Qualified business income deduction (QBI): What is it and who qualifies

The qualified business income (QBI) deduction is a tax benefit that allows pass-through business owners to deduct up to 20% of their qualified business income. Introduced by the Tax Cuts and Jobs Act (TCJA) of 2017, this provision also extends to 20% of qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income.

Available through to December 31, 2025, the QBI deduction provides several advantages:

• A reduction in effective tax rates for qualifying taxpayers.
• Incentives for entrepreneurial activity and reinvestment in businesses.
• Applicability across diverse industries.

Who qualifies for the qualified business income deduction?

The qualified business income deduction, also known as the Section 199A deduction, applies to most business activities, whether full-time or part-time. It is available to owners of pass-through entities like sole proprietorships, partnerships, S corporations, and certain LLCs, as well as to individuals earning qualified REIT dividends or publicly traded partnership income. Eligibility for the QBI deduction is determined by the following criteria:

Income eligibility

Your adjusted gross income (shown on Form 1040) determines your eligibility and the amount of your QBI deduction. However, you should note that it does not reduce your self-employment tax. For 2024, the thresholds are as follows:

• Single filers: Income below $191,950
• Married filing jointly: Income below $383,900

Once total taxable income surpasses these thresholds, the deduction is phased out. Consequently, incomes higher than $241,950 (single filers) or $483,900 (joint filers) are ineligible for the QBI deduction.

Eligible business structures

The QBI deduction applies exclusively to pass-through entities, which avoid double taxation by passing income directly to their owners. These include:

• Sole proprietors: Businesses owned and operated by a single individual without a formal legal structure.
• Partnerships: Businesses owned by two or more individuals who share profits, losses, and management responsibilities.
• S corporations: Corporations that elect to pass income, losses, and deductions through to shareholders for tax purposes.
• Limited liability companies (LLCs): Companies (LLCs) that elect to be taxed as partnerships or sole proprietorships, where income flows directly to the members.
• Trusts and estates: Legal entities managing assets for beneficiaries, with income passed through and taxed at the beneficiary’s level.

Specified service trade or business (SSTB)

Certain businesses classified as Specified Service Trades or Businesses (SSTBs) qualify for the deduction. Under IRC Section 199A(d)(2), a specified service trade or business (SSTB) is defined as a trade or business that meets any of the following criteria:

• provides services in accounting, health, law, actuarial science, athletics, brokerage services, consulting, financial services, or the performing arts; or
• provides services in investing and investment management, trading, or dealing in securities, partnership interests, or commodities; or
• derives much of its income from the reputation or skill of one or more of a firm’s owners or employees.

While SSTBs are eligible for the QBI deduction, their eligibility phases out entirely once taxable income exceeds the established upper-income threshold.

What income types are eligible for the QBI deduction?

Distinguishing between qualifying and non-qualifying income helps you to complete an accurate tax return and avoid penalties. Qualifying income for the QBI deduction includes the following categories:

• Ordinary business income: Taxable net income from domestic businesses operated as one of the qualifying entities.
• Rental income: The rental activity must qualify as a trade or business under Section 162, which is the ordinary or necessary expenses incurred paid or incurred in trading or running a business.
• Publicly traded partnerships (PTPs): Income from qualified PTPs refers to earnings distributed by entities that operate as partnerships but trade publicly. This income is mainly generated through sectors like energy, finance, and real estate.
• REIT dividends: Portion of earnings distributed to shareholders by a Real Estate Investment Trust (REIT). This is qualified dividend income generated by owning, operating, or financing real estate properties.

What income types are excluded from the QBI deduction?

Some types of income cannot be included in the QBI deduction. The IRS excludes the following:

• Wages and reasonable compensation: Income earned as an employee or reasonable compensation from an S corporation.
• Capital gains or losses: Proceeds from the sale of assets may not be included.
• Interest income: Interest is excluded unless directly tied to trade or business activity.
• Other exclusions: Income from commodities transactions, foreign currency gains, annuities, and payments made to partners for services outside their role of partner, such as consulting.

How to calculate QBI deduction

To calculate the QBI deduction, first identify your qualified business income and determine whether your taxable income falls within applicable thresholds. Consider any limitations, such as the wage-and-property tests or phase-outs specific to service trades or businesses (SSTBs). Each business’s QBI must be calculated separately to ensure the deduction is accurate and complies with IRS rules.

Step 1: Determine qualified business income

Start by calculating your business's taxable net income. This includes all ordinary income directly connected to your business operations but excludes non-qualifying income types, such as wages, guaranteed payments, and capital gains.

Step 2: Apply the 20% deduction rate

The basic QBI deduction is 20% of your taxable business income:

For example, if your QBI is $150,000, the deduction would be: $150,000 x 20% = $30,000

To arrive at this figure, you first determine your business income and expenses on Schedule C, then calculate your adjusted gross income on Form 1040. Only after these steps can you calculate the pass-through deduction.

Step 3: Apply income limits and phase-out rules

If your taxable income exceeds the income thresholds, additional calculations are required. These include the wage and property test, which limits the deduction based on W-2 wages paid and the unadjusted basis of qualified property, and the SSTB phase-out, which reduces or eliminates the deduction for service-based businesses. These tests ensure that the deduction is calculated accurately and aligns with IRS regulations.

• Wage and property test: The QBI component considers the greater ofsome text
  • 50% of W-2 wages paid by the business, or
  • 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after the acquisition of qualified property. Qualified property includes tangible assets like machinery, equipment, and buildings used in the business that are subject to depreciation.
• SSTB limits: The deduction phases out completely once you exceed the income threshold.

Step 4: Combine income sources

If you own multiple businesses, calculate the QBI separately for each trade or business. Then, total the amounts to determine the final deduction for your tax return.

Examples of QBI calculations

These examples show how the QBI deduction impacts the taxable income of business owners, with scenarios for both incomes below and above the applicable thresholds.

Example of income below the threshold

This example demonstrates the simplicity of the QBI deduction when the taxpayer's income is below the specified thresholds with no additional limitations.

Scenario:

Here's how to calculate the QBI deduction for income below the threshold:

1. Determine the qualified business income

• After allowable deductions, Jane’s taxable income is $80,000.

2. Apply the 20% deduction rate

• 20% of $80,000 = $16,000

3. Identify applicable thresholds

• A single-filing taxpayer in 2024 has a taxable income threshold of $191,950, with a phase-out range up to $241,950. Since Jane's taxable income is $80,000, it falls well below the income threshold and does not require any further tests.

Example of income above the threshold

When taxable income exceeds the threshold, the calculation becomes more complex due to the wage-and-property test. This example explains how these limitations impact the deduction.

Scenario:

Here's how to calculate the QBI deduction for income above the threshold:

1. Determine the qualified business income

• QBI includes the net income after deductions. In this case, it's $400,000.

2. Apply the 20% deduction rate

• 20% of $400,000 = $80,000

3. Identify applicable thresholds

• A married filing jointly taxpayer in 2024 has a taxable income threshold of $383,900, with a phase-out range up to $483,900. Since John's taxable income is $400,000, it falls within this range, necessitating the application of additional limitations.

4. Apply the wage and property test

This limitation is greater than 50% of W-2 wages paid by the business, or 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.

• 50% of W-2 wages: 50% of $150,000 = $75,000
• 25% of W-2 wages plus 2.5% of UBIA: 25% of $150,000 = $37,500

Therefore, $75,000 is the greater amount, reflecting the wage and property test’s emphasis on tying the deduction to tangible contributions like wages paid and investments. This allows businesses to benefit from actively supporting employment and economic growth.

5. Determine the QBI deduction

The QBI deduction is the lesser of:

• 20% of QBI ($80,000) or the wage and property limitation ($75,000). Therefore, in this scenario, John’s QBI deduction is limited to $75,000.

These two examples illustrate the application of the QBI deduction and highlight how income thresholds and limitations can influence the final deduction amount. While Jane’s case is straightforward, John’s demonstrates how higher income levels require applying the wage and property test, which reduces the allowable deduction.

For more complex cases, such as specified trade or businesses (SSTBs) with multiple income streams and phase-out thresholds, understanding key factors like W-2 wages, unadjusted property basis, and phase-out rules is essential. In these cases, consulting the IRS guidelines and the use of tax planning tools are helpful to ensure accurate calculations and compliance with tax regulations.

How to maximize the QBI deduction

Getting the most from the QBI deduction starts with having the right business type, accurately tracking income and expenses, and strategically managing your taxable income around the IRS thresholds.

• Review your business structure: Ensure your business type qualifies for the QBI deduction. If not, consider whether a structural change could improve your tax position, keeping in mind that the deduction is scheduled to expire on December 31, 2025. Long-term benefits, beyond just the QBI deduction, should guide this decision.
• Track income and expenses: Track income and expenses accurately with automated tools. Ramp's expense management platform automatically categorizes transactions and maintains detailed financial records, making it easier to calculate your QBI. You can track operating expenses separately from non-operating expenses, ensuring precise net income calculations and maintaining IRS compliance.
• Plan for income thresholds: If your income exceeds the IRS thresholds, implement strategies to manage your taxable income. Examples include contributing to retirement plans, prepaying deductible expenses, or deferring income to a subsequent year.

How can expense management simplify taxes?

Preparing for the QBI deduction isn’t just a tax-time task—it starts with how you manage your finances throughout the year. Accurate expense management is essential for getting an accurate taxable income figure, and expense automation is the fastest way through this process. By introducing automation tools into your business, you streamline the processing of expenses and ensure accurate financial data in time for tax season.

This is a snapshot of how automation transforms expense management:

Take advantage of the QBI deduction

The QBI deduction is one of the most valuable tax breaks available to business owners. It gives you the chance to lower your taxable income significantly, freeing up funds to reinvest profits and grow your business. By understanding the eligibility criteria and using accounting and automation tools, you can efficiently prepare the necessary financial data for your deduction. These tools help you to easily calculate taxable income by:

• Tracking W-2 wages and payments
• Separating qualifying and non-qualifying income
• Monitoring taxable income thresholds
• Categorizing expenses
• Storing financial documentation
• Integrating with tax software

By staying on top of your financial data year-round, you’re not only prepared to claim the QBI deduction but also building a stronger foundation for long-term business growth.