The Qualified Business Income (QBI) deduction—the Section 199A deduction—offers a powerful way to reduce taxable income for many business owners. Designed for sole proprietors, partners in partnerships, shareholders in S corporations, and certain trusts and estates, this tax break allows eligible taxpayers to deduct up to 20% of their QBI, as well as 20% of qualified dividends from Real Estate Investment Trusts (REITs) and income from Publicly Traded Partnerships (PTPs). However, income earned through a C corporation or as an employee does not qualify.
QBI includes the net income, gains, deductions, and losses from an eligible trade or business. Deductible expenses like self-employment tax, health insurance for the self-employed, and contributions to retirement plans (e.g., SEP, SIMPLE, and qualified plans) factor into the calculation. Understanding what qualifies as QBI is essential for maximizing this deduction and reducing overall tax liability.
The QBI deduction is available whether taxpayers itemize deductions or take the standard deduction beginning after December 31, 2017, and is currently set to expire after December 31, 2025.
Components of the QBI Deduction
The QBI deduction consists of two primary components:
- QBI Component: The portion is 20% of the qualified business income earned from a domestic business operating as a sole proprietorship, partnership, S corporation, trust, or estate. However, the amount that can be deducted is subject to several limitations. These include the type of trade or business conducted, the total W-2 wages paid by the business, and the unadjusted basis immediately after acquisition (UBIA) of qualified business property. Additionally, taxpayers who are patrons of agricultural or horticultural cooperatives may face further reductions in their allowable deduction.
- REIT/PTP Component: This portion allows a deduction of 20% of qualified REIT dividends and PTP income. Unlike the QBI component, this deduction is not affected by W-2 wages or the UBIA of business property. However, limitations may apply based on taxable income and the nature of the PTP’s business activities.
Deduction Limitations
The total QBI deduction is capped at the lesser of:
- The sum of the QBI and the REIT/PTP components.
- 20% of the taxpayer’s taxable income after subtracting net capital gains.
Two additional limitations may impact the QBI deduction. The wage and qualified property (WQP) limitation reduces the maximum deduction an owner can claim based on their share of a business’s W-2 wages and the unadjusted basis (original cost) of its qualified assets.
The specified service trade or business (SSTB) limitation restricts the QBI deduction for businesses in health, law, accounting, consulting, performing arts, financial services, and other professions where the principal asset is the skill or reputation of employees or owners. This includes income from endorsements, licensing of an individual’s likeness, and media appearances. The SSTB limitation phases in once taxable income exceed $394,000 for joint filers and $197,300 for other filers in 2025, with the deduction fully eliminated at the upper-income threshold of $494,600 for joint filers and $247,300 for other filers. However, this limitation does not affect the 20% deduction for income from Real Estate Investment Trusts (REITs) or Publicly Traded Partnerships (PTPs). Taxpayers below the threshold can claim the full deduction, while those within the phase-in range see a gradual reduction before it is completely disallowed for higher earners.
Exclusions from QBI
Certain types of income are not considered QBI, including:
- Investment income, such as capital gains or losses.
- Interest income unrelated to the business.
- Wages and salaries earned as an employee.
- Income not effectively connected with a U.S. business.
- Certain foreign currency gains or losses.
- Annuities, unless tied to the business.
- Reasonable compensation paid to S corporation shareholders.
- Guaranteed payments to partners.
- Qualified REIT dividends and PTP income.
Special Considerations for Rental Real Estate
A safe harbor rule is available for rental real estate enterprises seeking to qualify for the QBI deduction. If specific criteria are met, rental real estate activities may be classified as a trade or business for QBI purposes.
Even if a rental activity does not meet the safe harbor requirements, it may still qualify for the deduction if it is considered a trade or business under Section 162. Additionally, rental or licensing tangible or intangible property to a commonly controlled business can be treated as a qualified trade or business for QBI purposes.
The QBI deduction provides a valuable tax break for eligible business owners, reducing taxable income and lowering overall tax liability. However, its eligibility requirements and limitations can be complex. Contact your Stephano Slack tax manager/partner at 610-687-1600 or [email protected] to discuss your situation.
Author John J. Loughlin, Jr., CPA, Partner, leads the Tax & Advisory Services Department at Stephano Slack. He specializes in tax compliance, planning, and projections. His expertise and personalized approach help clients navigate complex tax matters, ensuring peace of mind and optimal outcomes. John can be contacted at 610-710-4045 or [email protected].
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