The 20% Qualified Business Income Deduction
By Kenneth H. Bridges, CPA, PFS May 2026
Included in The Tax Cuts and Jobs Act of 2017 (“TCJA”) was a new deduction for owners of pass-thru entities and sole proprietorships, the 20% “qualified business income” deduction (also referred to as the QBI deduction or IRC 199A deduction). This deduction was originally scheduled to expire at the end of 2025, but July 2025 legislation made the deduction permanent. Assuming you can qualify, the deduction can be up to as much as 20% of your profit from the business, which means shaving up to 7.4 percentage points off of your marginal tax rate.
The general rules – The deduction is computed at the individual owner level and is a unique type of deduction in that it does not reduce adjusted gross income but can be claimed without regard to whether you itemize. In general, the deduction is equal to 20% of K-1 or Schedule C “qualified business income”, which does not include interest, dividends and capital gains (so you cannot double dip and get the lower rate on qualified dividends and capital gains while claiming this deduction on the same income). In order to qualify for this special deduction, you have to meet one of two tests.
- If your taxable income on married joint return is less than $403,500 (or up to $553,500 with partial deduction; and 1/2 of these amounts for single persons), then you will automatically qualify almost regardless of the type of business, and regardless of the amount of W-2 wages (if any) paid by the business; or
- Alternatively, if your taxable income on married joint return will exceed $403,500 (or up to $553,500 for partial deduction; and 1/2 of these amounts for single persons), then the business cannot be a “specified service business” (defined further below), and your deduction is limited to the lesser of 20% of your profit from the business or 50% of your proportionate share of the W-2 wages paid by the business (or 25% of the W-2 wages plus 2.5% of the original cost of depreciable assets).
The $403,500 and $553,500 are 2026 amounts. The amounts are increased each year for inflation.
The more detailed rules – The regulations are divided into six sections: (1) operational rules; (2) determination of W-2 wages and basis of depreciable property; (3) qualified business income; (4) aggregation of businesses; (5) specified service businesses and the business of being an employee; and (6) relevant passthrough entities. Each of these is discussed further below.
Operational rules – As noted above, there are essentially two sets of rules; one for individuals with income below $201,750 (or $403,500 for couples filing a joint return), and one for individuals or couples with taxable income above these threshold amounts. If your income is below the threshold level, then almost any type of ordinary business income (other than W-2 income or K-1 guaranteed payments) will qualify for the 20% deduction (i.e. 1099-NEC income, Schedule C profit and K-1 income normally qualify). Once your taxable income (as computed after all of your personal deductions other than the 20% QBI deduction) goes above the threshold amount, then the rules get much more complicated and a number of potential limitations kick in (e.g. the income cannot be from a specified service business and your deduction cannot exceed your share of 50% of the W-2 wages paid by the business or 25% of the W-2 wages plus 2.5% of the original cost of depreciable assets). The deduction, while computed separately with respect to each flow-through business (unless you qualify under the “aggregation” rules), cannot exceed your net combined qualified business income from all flow-through entities nor 20% of your taxable income in excess of net capital gain. The income must be effectively connected to a business conducted within the U.S., and losses carry forward to reduce such income in the following year. “Reasonable compensation” (including K-1 guaranteed payments) is excluded from qualified business income. The deduction is for income tax purposes only, not for computing self-employment tax or the 3.8% Medicare tax on net investment income. Qualified REIT dividends and K-1 income from publicly traded partnerships are eligible for the deduction, and estates and trusts are eligible to claim the deduction.
Determination of W-2 wages and basis of depreciable property – The deduction is designed to encourage jobs creation, so (once your income goes over the threshold amounts discussed above) your deduction is generally limited to the lesser of 20% of your profit or 50% of your share of the W-2 wages paid by the business. In a concession to asset-intensive businesses (e.g. real estate), an alternative is provided to the 50% of wages paid limitation, whereby you can instead use 25% of the W-2 wages paid plus 2.5% of the original cost of the depreciable assets of the business (which have been held for less than the longer of 10 years or the specified depreciable lives of the assets). W-2 wages paid to a company’s common law employees by a third party (e.g. a PEO or an affiliated company) can qualify.
Qualified business income – Qualified business income (QBI) is ordinary business income (not interest, dividends or capital gain) from 1099-NEC, Schedule C or K-1, plus qualified REIT dividends and qualified publicly-traded partnership income. It does not include the W-2 compensation of an S-corp shareholder, nor the K-1 “guaranteed payments” paid to a partner. Notably, while the IRS may assert that an S-corp shareholder’s W-2 compensation has been understated (thus potentially overstating the 20% deduction), the IRS has indicated that it will not make this assertion with respect to partner guaranteed payments (creating the potential opportunity for partners to maximize the QBI deduction by favoring “distributive share” allocations over “guaranteed payments”). Ordinary income from the sale of a partnership interest (IRC 751 income) and income from the change of an accounting method (IRC 481 income) qualify as QBI. Your QBI for the year will be reduced by losses suspended in previous years under the passive loss rules, basis limitation rules and at-risk rules only if the losses were suspended in a tax year after 2017. Finally, only income from business conducted in the U.S. will qualify.
Aggregation of businesses – So what if you have structured your business through multiple entities, with most of the profit concentrated in one entity while most of the payroll is concentrated in another entity? When the legislation was first enacted, there was some concern that many businesses might have to restructure in order to maximize the owners’ QBI deduction. The regulations, however, provide some relief here, by permitting individuals to elect to aggregate businesses in computing the QBI deduction limitations, so long as the same group of persons, directly or indirectly, owns at least 50% of each business being aggregated, and each of the businesses meet at least two of three other factors: (1) products or services which are the same or customarily offered together; (2) shared facilities or centralized business elements like accounting and HR; and (3) operated in coordination with or reliance upon one or more of the businesses in the group. Note that you cannot include a specified service business in your aggregated group.
Specified service businesses and the business of being an employee – Once your personal taxable income goes over the threshold amount, you are denied the deduction with respect to profit from a “specified service trade or business” (SSTB). Also, income received as an employee is ineligible for the deduction, regardless of your income level. An SSTB is defined for these purposes as “any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners”. Engineering and architectural firms (which were originally included in the list of bad businesses), were specifically carved out by Congress (and thus enjoy the favorable benefit). With respect to the “reputation or skill” exclusion, the IRS has essentially limited this to those situations where someone lends their name to a business in exchange for a royalty or receives an endorsement fee or an appearance fee. With respect to the term “consulting”, the regulations define such for these purposes as “the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems”. The regulations go on to say “consulting does not include the performance of services other than advice and counsel, such as sales or economically similar services or the provision of training and educational courses”. Real estate agents and brokers and insurance agents and brokers are specifically carved out from the definition of “brokerage services”, and thus may enjoy the benefit (unless limited by another provision such as the “financial services” exclusion or the lack of W-2 wages paid). “Statutory employee” income (which is reported on Schedule C) can potentially qualify for the QBI deduction.
Relevant passthrough entities – While the QBI deduction is ultimately computed and claimed on individual returns, many of the determinations (e.g. whether or not the business is an SSTB) and computations (e.g. the individual owner’s share of W-2 wages paid and original cost basis of depreciable property) must be made at the “relevant passthrough entity” (RPE; e.g. S-corp or partnership) level and reported to the owners on their Schedule K-1s. If the RPE fails to properly report these items to the owner, then the amounts are presumed to be zero. Accordingly, it is very important that passthrough entities get this reporting right.
Planning to maximize the QBI deduction – Much of our planning in order to maximize the QBI deduction for our clients includes (1) avoiding SSTB classification (e.g. taking great care with how the business is described on tax returns, at website, in marketing materials, etc.); (2) keeping taxable income below the threshold amounts in order to avoid the SSTB rules and 50% of W-2 wages paid limitation; (3) electing S status where necessary in order to get sufficient W-2 wages paid; (4) optimizing the mix of S-corp shareholder W-2 compensation and K-1 flow through income; (5) restructuring partnership agreements to favor “distributive share” over “guaranteed payments”; and (6) taking advantage of the “aggregation” rules.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact your legal counsel.