Understanding the Qualified Business Income Deduction

For any small business owner or self-employed professional, the Qualified Business Income (QBI) deduction is one of the most valuable tax breaks available. Yet, many taxpayers either forget about it or do not take full advantage of the deduction. Understanding how it works, who qualifies, and how to maximize it can save you a significant amount in taxes. This guide breaks down the QBI deduction in plain English, without requiring an accounting degree.

What Is the Qualified Business Income Deduction?

The QBI deduction, also known as Section 199A, was created under the Tax Cuts and Jobs Act of 2017. Its main purpose is to provide a tax incentive for small business owners and pass-through entities businesses that report income on individual tax returns instead of corporate tax returns.

The deduction allows eligible business owners to deduct up to 20% of their qualified business income from taxable income. This deduction is applied after calculating your taxable income but before applying any other deductions or credits.

Who Qualifies for the QBI Deduction?

Let’s talk about what would allow one to enjoy the QBI deduction benefits. Eligibility depends on the following characteristics:

1. Type of Business
   Your business must be a pass-through entity like sole proprietorship, S corp, or partnership.
2. Type of Income
   Only income from a “qualified trade or business” counts. This excludes investment income like dividends or capital gains.
3. Income Level
   This is the level where QBI income limits come into play.

   For tax year 2025 (estimated limits based on inflation adjustments):

   • Single filers: ~$191,000
   • Married filing jointly: ~$382,000

If your income falls below these thresholds, you can generally claim the full 20% deduction. Above these limits, restrictions apply, especially if your business is a Specified Service Trade or Business (SSTB).

What Is a Specified Service Trade or Business (SSTB)?

SSTBs are businesses that rely heavily on the skill, reputation, or talent of the owner or employees. Common SSTBs include:

• Accountants

• Doctors

• Lawyers

• Consultants

• Financial advisors

• Athletes and performing artists

If you own an SSTB and your income exceeds the thresholds mentioned above, your QBI deduction phases out gradually. Once your income is significantly above the threshold, you may not qualify at all.

Example:

A law firm owner earning $450,000 may see their deduction reduced or eliminated because the SSTB rules limit the QBI deduction for high-income earners in specified service fields.

How to Maximize the QBI Deduction

Even if your income is near or above the thresholds, there are strategies to maximize your QBI deduction:

1. Lower Your Taxable Income

Reducing taxable income can help you stay under thresholds or maximize your deduction:

• Max out retirement contributions: Contributing to a 401(k), SEP IRA, or SIMPLE IRA can reduce taxable income.

• Charitable donations: Cash or property donations to qualified charities lower taxable income.

• Fully deduct business expenses: Ensure all legitimate expenses like office supplies, utilities, and travel are accurately reported.

2. Pay Yourself Strategically

For S corporation owners, how you pay yourself can impact the deduction:

• Ensure W-2 wages are reasonable but not excessive.

• Balance salary and distributions to optimize the deduction while remaining compliant with IRS rules.

3. Consider Entity Restructuring

Changing your business entity or tax classification can affect your deduction:

• Switching from a sole proprietorship to an S corporation may help high-income owners reduce taxable income via salary versus distributions.

• Partnerships may explore restructuring to allocate profits more favourably for QBI purposes.

4. Aggregate Related Businesses

If you own multiple businesses, the IRS allows aggregation under certain rules:

• This can help meet wage or property requirements.

• Aggregating related businesses may allow a higher QBI deduction.

5. Shift Income Within the Family

Employing family members in your business may shift income into lower tax brackets:

• You can pay wages to children or spouses who are in lower brackets, keeping income in the family while still qualifying for deductions.

6. Invest in Qualified Property

For high-income earners, the value of qualified business property can enhance the deduction:

• Buying new equipment, machinery, or property may increase the deduction, especially when QBI deduction is limited by wages or property.

Additional Strategies for Advanced Planning

1. Defer Income

   • Delay recognizing some business income until the next tax year to stay under thresholds.

2. Accelerate Expenses

   • Prepay certain business expenses (like rent or supplies) to reduce taxable income in the current year.

3. Use Retirement Plans Strategically
   • Consider defined benefit plans for high-income business owners to significantly increase deductible contributions.
4. Keep Accurate Records
   • Maintaining detailed records is essential for businesses with multiple entities, SSTB concerns, or property investments.

Common Mistakes to Avoid

• Forgetting to consider QBI for multiple business entities.
• Misclassifying income from SSTBs.
• Ignoring W-2 wage requirements for S corporations.
• Failing to account for property-based limitations for high-income earners.
• Not consulting a tax professional when your income is near phase-out thresholds.

Real-World Example of QBI Deduction

Scenario 1: Sole Proprietor Below Threshold

• Income: $150,000

• Business type: Non-SSTB
• Deduction: 20% of $150,000 = $30,000

Scenario 2: S Corp Owner Above Threshold (SSTB)

• Income: $450,000

• Business type: Law firm (SSTB)
• Deduction: Phased out due to SSTB rules; only partial deduction may apply

Scenario 3: Multiple Businesses

• Income: $350,000 combined

• Aggregation of related businesses helps meet wage and property requirements, maximizing deduction

Final Thoughts

The Qualified Business Income deduction can result in substantial tax savings for small business owners and self-employed professionals. However, income thresholds, SSTB restrictions, and phase-out rules make it complex.

• Eligibility: Understand if your business qualifies.
• Planning: Strategic tax planning can maximize the benefit.
• Professional Advice: Consulting a tax advisor experienced in Section 199A ensures you fully utilize the deduction.

Need Personalized Advice? KB Tax Devisers specializes in helping business owners navigate complex tax rules to maximize savings. Contact us to find out how much you can save with the QBI deduction.