The Qualified Business Income (QBI) deduction under Section 199A allows eligible owners of pass-through businesses to deduct up to 20% of qualified business income from taxable income. The provision was introduced to address the difference in tax treatment between C corporations and pass-through businesses following the reduction of the federal corporate tax rate under the Tax Cuts and Jobs Act (TCJA). The One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, made the QBI deduction permanent, widened the income phase-in ranges, and introduced a new $400 minimum deduction for 2026, subject to material participation requirements.
For business owners, however, the QBI deduction is not simply a flat 20% deduction. The actual benefit depends on taxable income, the nature of the business, W-2 wages, qualified property, and other statutory limitations. The distinction becomes particularly important for Specified Service Trades or Businesses (SSTBs), where the deduction can be significantly restricted as income rises.
Background
When the TCJA reduced the federal corporate income tax rate for C corporations from 35% to 21% in 2017, it created a difference in the tax treatment of businesses operating through pass-through structures.
Partnerships, S corporations, and sole proprietorships generally do not pay income tax at the entity level. Instead, their income passes through to their owners and is taxed at the individual level. Since individual tax rates remained significantly higher than the new 21% corporate rate, Congress introduced the QBI deduction under Section 199A to narrow this gap while retaining the pass-through structure.
Broadly, Section 199A allows eligible owners of pass-through businesses to deduct up to 20% of qualified business income from taxable income. The deduction is claimed directly on the owner’s Form 1040 and is subject to several limitations and special rules.
The QBI deduction had originally been scheduled to sunset after 2025. The OBBBA, signed on July 4, 2025, made the deduction permanent and changed several of its mechanics from 2026 onward.
A separate proposal, H.R. 8415, the Small Business Tax Cut Act, would increase the deduction rate from 20% to 23%. However, the proposal has not been enacted as of the date of the alert.
The Two Components, and Why the Distinction Matters
The Section 199A deduction consists of two separate components:
- The QBI component: Up to 20% of qualified business income from qualified trades or businesses, subject to applicable wage, property, and SSTB rules.
- The REIT/PTP component: 20% of qualified REIT dividends and qualified publicly traded partnership income, calculated separately.
These components are then combined. However, the final deduction is subject to an overall limitation. Broadly, the deduction is limited to the lesser of the combined amount or 20% of taxable income reduced by net capital gain.
This limitation can materially affect taxpayers whose income includes significant capital gains. Even where business income remains unchanged, the final QBI deduction can be constrained by the taxable-income limitation.
Determination of QBI Component
The starting point for the Section 199A calculation is determining what qualifies as Qualified Business Income.
QBI generally refers to the net amount of qualified items of income, gain, deduction, and loss connected with a qualified trade or business conducted in the United States. The relevant income must be effectively connected with the conduct of a trade or business within the United States and included in determining taxable income.
QBI is therefore not necessarily the same as the overall income or profit of a business. Section 199A specifically excludes several categories of income and payments, including:
- Capital gains and losses
- Dividends
- Certain interest income
- Certain foreign currency and CFC-related items
- Annuity income that is not business income
- Owner compensation
- W-2 wages received by an individual
- Interest income that is not properly allocable to a trade or business
- Reasonable compensation paid to an owner for services
- Guaranteed payments paid to an owner for services rendered to the business
A qualified trade or business generally includes a trade or business conducted in the United States, subject to specific exclusions.
One of the most important exclusions relates to Specified Service Trades or Businesses.
SSTBs generally include businesses operating in areas such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Certain businesses where the principal asset is the reputation or skill of one or more employees or owners can also fall within the SSTB rules.
Engineering and architecture businesses, however, are specifically excluded from the SSTB definition.
De Minimis Exception for SSTBs
A business that performs some specified services does not automatically become an SSTB in every situation. The regulations provide a de minimis exception based on the proportion of gross receipts attributable to specified services.
Where gross receipts are $25 million or less, a business generally will not be treated as an SSTB if less than 10% of its gross receipts are attributable to specified services.
Where gross receipts exceed $25 million, the applicable threshold is reduced to 5%.
This distinction can be particularly relevant for businesses that provide a combination of qualifying and specified services.
Determination of the REIT/PTP Component
Section 199A also provides a separate deduction for certain qualified REIT dividends and qualified publicly traded partnership income.
These amounts are not included in QBI itself. Instead, they are considered separately when calculating the overall Section 199A deduction.
Qualified REIT dividends can generally qualify for a separate deduction of up to 20% and are not subject to the SSTB limitation.
Qualified PTP income can also qualify for the separate deduction. However, PTP income attributable to an SSTB may be subject to the applicable SSTB rules.
A Real Estate Investment Trust (REIT) generally owns, operates, or finances income-producing real estate and elects REIT tax status. Subject to the applicable requirements, certain REIT dividends received by taxpayers may qualify for the separate Section 199A deduction.
A Publicly Traded Partnership (PTP) is generally a partnership whose interests are traded on an established securities market or an equivalent secondary market and that satisfies the requirements under Section 7704. Certain ordinary, non-capital-gain income from a PTP may qualify as qualified PTP income.
QBI Deduction & Limitation
The calculation of the QBI deduction depends heavily on the taxpayer’s taxable income before the QBI deduction.
For 2026, the relevant thresholds are:
| Particulars | Single / HOH | Married Filing Jointly |
| Threshold amount | $201,750 | $403,500 |
| Phase-in range width | $75,000 | $150,000 |
| Top of phase-in range | $276,750 | $553,500 |
The OBBBA increased the phase-in range from $50,000 to $75,000 for single taxpayers and from $100,000 to $150,000 for married taxpayers filing jointly.
Regime A: Below the Threshold
Below the threshold amount, the calculation is relatively straightforward.
There is no requirement to apply the W-2 wage test, qualified property test, or SSTB distinction. This means that even an SSTB can receive the full deduction within this income range.
The deduction is generally the lesser of:
- 20% of QBI, or
- 20% of taxable income minus net capital gain.
Regime B: Inside the Phase-In Range
Once taxable income crosses the threshold, limitations begin to phase in.
For a qualified business, the wage and qualified property limitations begin to affect the deduction. The deduction is generally 20% of QBI, reduced by the applicable phase-in percentage of the amount exceeding the wage and property limitation.
For an SSTB, the calculation is more restrictive. QBI, W-2 wages, and UBIA of qualified property are first multiplied by the applicable percentage before the wage and property limitation is applied.
For example, consider two taxpayers with taxable income of $230,000, QBI of $180,000, W-2 wages of $40,000, and UBIA of qualified equipment of $60,000.
At $230,000 of taxable income, the amount exceeding the $201,750 threshold is $28,250. Against the $75,000 phase-in range, this produces a phase-in percentage of approximately 37.67% and an applicable percentage of approximately 62.33%.
For a non-SSTB equipment rental business, the calculation produces a QBI deduction of approximately $29,973 after applying the wage/property limitation and phase-in reduction.
For a solo dental practice treated as an SSTB, the same income, wages, and property produce a substantially lower deduction of $12,467.
The difference demonstrates why SSTB classification matters. The SSTB calculation reduces QBI, wages, and qualified property before the wage test is applied. Treating the SSTB and non-SSTB calculations as interchangeable can therefore significantly overstate the available deduction.
Regime C: Above the Phase-In Limit
Once taxable income exceeds the top of the phase-in range, the full limitations apply.
Consider a manufacturing business owner with:
- Taxable income of $300,000
- QBI of $220,000
- W-2 wages of $70,000
- UBIA of equipment of $150,000
The 20% QBI amount is $44,000.
The wage/property limitation is the greater of:
- 50% of W-2 wages, or
- 25% of W-2 wages plus 2.5% of UBIA of qualified property.
Here, 50% of W-2 wages is $35,000, while the alternative calculation produces $21,250. Therefore, the applicable limitation is $35,000.
The final QBI deduction is consequently $35,000 rather than the $44,000 produced by the initial 20% QBI calculation.
For SSTBs, the consequences can be even more significant. Once taxable income is above the applicable phase-in limit, an SSTB is no longer treated as a qualified trade or business for purposes of Section 199A, meaning no QBI deduction is available from that business.
Losses and Negative QBI
A loss year does not simply eliminate a business’s contribution to the QBI calculation. It can result in negative QBI.
Within the same year, losses from one business must first offset income from another business before the deduction is calculated. A taxpayer cannot simply isolate the profitable business and ignore the loss-making business.
If aggregate QBI is negative for the year, the deduction for that year is zero. The negative amount carries forward indefinitely and must reduce QBI in future years before a deduction can be calculated.
This QBI treatment is separate from limitations involving basis, at-risk rules, and passive activity rules, which continue to govern taxable income separately.
Looking Ahead: Could the QBI Deduction Increase to 23%?
The current Section 199A deduction is generally capped at 20% of qualified business income. However, proposed legislation could increase the benefit.
The Small Business Tax Cut Act, H.R. 8415, introduced in the House on April 23, 2026, proposes increasing the deduction from 20% to 23%, along with changes to certain income-based limitations and other provisions affecting eligible taxpayers.
If enacted, the proposed changes would generally apply to taxable years beginning after December 31, 2026.
Until such legislation is enacted, taxpayers should continue to apply the existing 20% framework.
Compliance & Forms
The QBI deduction can be claimed using Form 8995 or Form 8995-A.
Form 8995 is generally used for taxpayers with income below the applicable thresholds and simpler QBI calculations. Form 8995-A applies to taxpayers with above-threshold income and situations involving more complex calculations, including aggregation elections.
The deduction can be claimed whether or not the taxpayer itemizes deductions.
Accurate recordkeeping remains important. Taxpayers should maintain appropriate records relating to:
- Entity type
- QBI
- W-2 wages
- Qualified property and UBIA
- Domestic and foreign income
- Nature of the business activity
- Applicable aggregation elections
Aggregation can also be an important planning consideration where a taxpayer owns multiple related businesses. Generally, businesses must have at least 50% common ownership, consistent tax-year reporting, and satisfy the applicable requirements. They must also generally satisfy at least two relevant factors, such as offering similar or commonly combined products or services, sharing significant centralized functions, or operating in coordination with one another.
The QBI deduction is a federal income tax provision. State treatment can differ because states have their own conformity rules. Each state jurisdiction should therefore be reviewed separately to determine whether the federal Section 199A treatment flows through or requires a state-level adjustment.
For eligible taxpayers, planning around aggregation elections, wages, retirement contributions, and capital investment can have a meaningful effect on the deduction. For professional service businesses, SSTB classification and income management become particularly important as taxable income approaches or exceeds the applicable thresholds.
The QBI deduction remains an important mechanism for narrowing the tax-rate difference between pass-through businesses and C corporations. But the benefit is highly dependent on the taxpayer’s facts. Understanding the applicable income regime, business classification, wage and property limitations, and compliance requirements is essential before determining the actual deduction available.
FAQs
What is the QBI deduction?
The QBI deduction is a federal income tax deduction under Section 199A that generally allows eligible owners of pass-through businesses to deduct up to 20% of qualified business income from taxable income.
Which businesses can qualify for the QBI deduction?
Eligible businesses can include sole proprietorships, partnerships, and S corporations, subject to the requirements and limitations under Section 199A.
What is an SSTB?
A Specified Service Trade or Business includes certain businesses in fields such as health, law, accounting, consulting, financial services, and other specified activities. SSTBs are subject to special income-based limitations.
What are the 2026 QBI thresholds?
For 2026, the threshold amount is $201,750 for single taxpayers and heads of household and $403,500 for married taxpayers filing jointly. The phase-in ranges extend by $75,000 and $150,000 respectively.
Does the QBI deduction remain at 20%?
The current deduction generally remains at 20%. H.R. 8415, the Small Business Tax Cut Act, proposes increasing the rate to 23%, but the proposal has not been enacted as of the date of the alert.
Are REIT dividends included in QBI?
Qualified REIT dividends are not included in QBI. They are considered separately under the REIT/PTP component of the Section 199A deduction and may generally qualify for a separate deduction of up to 20%.
Which forms are used to claim the QBI deduction?
Form 8995 is generally used for simpler, below-threshold calculations, while Form 8995-A is used for above-threshold taxpayers and more complex situations, including aggregation elections.
Do state tax rules follow the federal QBI deduction?
Not necessarily. Each state has its own conformity rules, so the federal Section 199A treatment should be independently reviewed for each state jurisdiction.
About M2K Advisors
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Disclaimer: This article is intended for general guidance only and should not be considered tax advice or an opinion. On any specific matter, reference should be made to the appropriate advisor.
