The QBI Deduction (Section 199A): How the 20 Percent Pass-Through Deduction Works

Section 199A, commonly called the QBI deduction, is one of the most valuable provisions for pass-through business owners and one of the least understood. It reduces taxable income (not self-employment tax) by up to 20 percent of qualified business income, subject to limits. Because it interacts with salary, retirement contributions, and entity choice, it belongs in any planning conversation.

The basics

Introduced by the 2017 tax law, the deduction was originally scheduled to expire after 2025. Legislation enacted in 2025 made the deduction permanent and adjusted certain thresholds, so confirm the current rules and figures. In general terms:

The deduction applies to individuals, trusts, and estates with qualified business income from a sole proprietorship, partnership, S-corporation, or LLC taxed as one of those. C-corporations do not qualify.
The deduction is taken on the owner's personal return below the line for adjusted gross income, whether or not the owner itemizes.
The deduction is generally 20 percent of qualified business income (QBI), limited to 20 percent of taxable income minus net capital gains.
It does not reduce self-employment tax or the net investment income tax.

What counts as qualified business income

QBI is the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business within the United States. It generally is ordinary business income after deductions, including deductions for one-half of self-employment tax, the self-employed health insurance deduction, and retirement plan contributions attributable to the business. It excludes:

W-2 wages paid to the owner-employee of an S-corp. Salary is not QBI.
Guaranteed payments to partners for services.
Capital gains and losses, dividends, and interest income not properly allocable to the business.
Certain other items.

For S-corp owners, QBI is the K-1 income after the owner's salary and related deductions. That is why the salary level directly affects the QBI amount. See setting your owner salary in an S-corp.

The threshold: below and above

Below a taxable income threshold (for 2025, $197,300 for single filers and $394,600 for joint filers, subject to indexing and recent legislative changes), the deduction generally equals 20 percent of QBI, without regard to wage and property limits or the type of business. Above the threshold, and through a phase-in range, two limitations begin to apply:

The W-2 wage and property limit. The deduction from each business is limited to the greater of (a) 50 percent of the W-2 wages paid by the business, or (b) 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of qualified property (UBIA) immediately after acquisition, such as depreciable property still within its depreciable period.
The specified service trade or business (SSTB) limitation. Businesses in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and businesses where the principal asset is the reputation or skill of employees or owners generally lose the deduction as taxable income rises through the phase-in range, and it is unavailable above the top of the range. Engineering and architecture are excluded from the SSTB definition.

Recent legislation changed the width of the phase-in range for some taxpayers, so confirm current details.

Marketing agencies and consultants

Many agency and consulting businesses wonder whether they are an SSTB. The definition of "consulting" is narrow in the regulations, and there is a category (reputation or skill) that is applied narrowly to specific fact patterns like endorsement income or licensing of a name. Whether your services fit depends on the facts. Get individualized advice. See marketing agency entity structure and consulting business structure.

How salary affects the deduction

For an S-corp:

Lower salary increases QBI (K-1 income), which raises the potential 20 percent deduction, but reduces the W-2 wages, which matters when the wage limit applies.
Higher salary decreases QBI but increases the W-2 wage base for the limit.
Below the threshold, wages do not limit the deduction, so lower salary tends to increase the deduction (subject to reasonable compensation).
Above the threshold, the wage limit may bind, and the balance shifts.

Because reasonable compensation is required regardless, the modeling exercise is usually to test a defensible range and see how the deduction changes. See S-corp reasonable compensation.

Retirement contributions and other deductions

Contributions to a retirement plan for the owner reduce QBI when they are attributable to the business (for a sole proprietor, the self-employed retirement plan deduction reduces QBI). But they also reduce taxable income, and the net effect on total tax is usually positive. The self-employed health insurance deduction also reduces QBI. See retirement plans for S-corp owners and self-employed health insurance deduction.

Losses and carryovers

If the total QBI from all businesses is a loss, no QBI deduction is allowed for the year, and the loss carries forward to reduce QBI in future years. Losses from one business can offset income from another for QBI purposes, subject to loss limits under other tax rules (basis, at-risk, passive activity, and excess business loss). See tax basis basics.

Aggregation

Owners with multiple businesses may be permitted to aggregate them for purposes of applying the wage and property limits if certain conditions are met (common ownership, same tax year, and integration factors). Aggregation can help when one business has high wages and another has high income but few wages. It requires disclosure on the return and consistent treatment in later years. Consult a professional.

Rental real estate

Rental activity may qualify as a trade or business for QBI if it rises to the level of a business, and the IRS provided a safe harbor with requirements such as 250 hours of rental services per year and separate books. Real estate rented to a commonly controlled business can also qualify. See owning your building in a separate LLC.

Anti-abuse and planning cautions

Splitting a business to place income in different entities to avoid SSTB limits is scrutinized under specific rules that treat related businesses as one for certain purposes. Do not create entities solely to game the deduction. Increased wages to reach the wage limit come with payroll tax costs, so the net benefit must be evaluated. Also note that state income taxes do not necessarily follow the federal deduction.

Documentation and reporting

The deduction is computed on Form 8995 (simplified) or Form 8995-A (with limitations). S-corps and partnerships must report QBI, W-2 wages, and UBIA information to owners on the K-1 supplemental statement. Your preparer needs accurate wage and asset records. See S-corp tax return guide.

Common mistakes

Assuming self-employment tax is reduced.
Ignoring SSTB status.
Not considering the wage limit when income rises above the threshold.
Treating S-corp salary as QBI.
Failing to track losses carried forward.
Assuming the rules are unchanged after recent legislation.
Overlooking the interaction with retirement plan and health insurance deductions.
Missing the impact of rental activity.

Planning approach

Estimate your taxable income and where it falls relative to the thresholds.
Determine whether each business is an SSTB.
Compute QBI, W-2 wages, and UBIA for each business.
Model salary and retirement contributions.
Consider timing of asset purchases, which affect UBIA and taxable income.
Recheck in the fall when projections are clearer.

For help modeling the deduction with your entity and salary, AE Tax Advisors can assist, and a discovery call is a good first step. See also when to elect S-corp status.