QBI Deduction (Section 199A)

The Qualified Business Income (QBI) deduction, also known as the Section 199A deduction or the pass-through deduction, is one of the most significant tax benefits available to business owners. Understanding its calculation rules, income thresholds, and limitations is essential for EA exam success.

What Is the QBI Deduction?

Section 199A, enacted by the Tax Cuts and Jobs Act of 2017, allows eligible taxpayers to deduct up to 20% of their qualified business income from domestic businesses operated as:

• Sole proprietorships (Schedule C)
• Partnerships (Form 1065, Schedule K-1)
• S corporations (Form 1120-S, Schedule K-1)
• Trusts and estates (Form 1041)

Important: The QBI deduction does NOT apply to:

• Income from C corporations (taxed at the corporate level)
• Employee wages (W-2 income)
• Investment income (interest, dividends, capital gains)
• Income earned outside the United States

Basic QBI Deduction Calculation

The basic formula for the QBI deduction is straightforward:

QBI Deduction = Lesser of:

1. 20% of Qualified Business Income, OR
2. 20% of Taxable Income (calculated before the QBI deduction, minus net capital gains)

Example: A single taxpayer has $80,000 of QBI from a sole proprietorship and taxable income (before QBI deduction) of $100,000 with no capital gains.

• 20% of QBI = $80,000 x 20% = $16,000
• 20% of Taxable Income = $100,000 x 20% = $20,000
• QBI Deduction = Lesser amount = $16,000

2024 Income Thresholds

The complexity of the QBI deduction depends on your taxable income level. For 2024:

Below the Lower Threshold: Simplified calculation - no W-2 wage or capital limitations apply. You can claim the full 20% deduction regardless of business type.

Within the Phase-Out Range: Limitations begin to apply proportionally.

Above the Upper Threshold: Full W-2 wage/capital limitations and SSTB restrictions apply.

The W-2 Wage and Capital Limitation

For taxpayers with taxable income above the threshold amounts, the QBI deduction is limited to the greater of:

Option A: 50% of the taxpayer's share of W-2 wages paid by the business

OR

Option B: 25% of W-2 wages PLUS 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property

What is UBIA? The unadjusted basis immediately after acquisition of qualified property means the original cost basis of tangible depreciable property (buildings, equipment, machinery) used in the business, without reduction for depreciation, Section 179 expense, or bonus depreciation. Property must be held and used in the business during the tax year and at year-end.

UBIA Recovery Period: Property qualifies until the later of:

• 10 years after placed in service, OR
• The end of the last full year of the property's recovery period under Section 168

Example - W-2 Wage/UBIA Limitation: A single taxpayer with taxable income of $300,000 (above the $241,950 threshold) has:

• QBI of $200,000
• W-2 wages paid: $60,000
• UBIA of qualified property: $400,000

Limitation calculation:

• Option A: 50% x $60,000 = $30,000
• Option B: (25% x $60,000) + (2.5% x $400,000) = $15,000 + $10,000 = $25,000
• Greater of A or B: $30,000
• 20% of QBI: $200,000 x 20% = $40,000
• QBI Deduction: Limited to $30,000 (the wage/capital limitation)

Specified Service Trades or Businesses (SSTBs)

SSTBs face the most restrictive rules under Section 199A. If your business involves services in any of these fields, special limitations apply:

SSTB Categories:

Important Exclusions: Engineers and architects are specifically excluded from SSTB classification and can claim the full QBI deduction regardless of income.

SSTB Phase-Out Rules for 2024:

• Below $191,950 (single) / $383,900 (MFJ): Full QBI deduction available
• $191,951 - $241,950 (single) / $383,901 - $483,900 (MFJ): Partial deduction (ratably reduced)
• Above $241,950 (single) / $483,900 (MFJ): NO QBI deduction for SSTB income

REIT Dividends and PTP Income Component

The total Section 199A deduction has two components:

1. QBI Component: 20% of QBI from qualified trades or businesses (subject to limitations discussed above)

2. REIT/PTP Component: 20% of qualified REIT dividends and qualified publicly traded partnership (PTP) income

Critical Rules for REIT/PTP Component:

• NOT subject to W-2 wage or UBIA limitations
• NOT subject to SSTB restrictions (except for PTP income from SSTB activities above threshold)
• Qualified REIT dividends and qualified PTP income must be netted together before applying 20%
• If combined REIT/PTP amount is a loss, it carries forward to offset future REIT/PTP income (not QBI)
• Reported on Form 1099-DIV, Box 5 for REIT dividends

Total QBI Deduction Formula:

Total Deduction = QBI Component + REIT/PTP Component
(Limited to 20% of Taxable Income minus Net Capital Gains)

Multiple Business Aggregation

Taxpayers with multiple businesses may aggregate them for QBI deduction purposes if certain criteria are met:

• Common ownership (50% or more)
• Same tax year
• Businesses share at least 2 of 3 factors: centralized purchasing, shared administrative services, or shared facilities/employees

Benefits of aggregation: Allows netting of QBI across businesses and combining W-2 wages and UBIA from multiple businesses for limitation calculations.

Netting rule: If one business has a loss, it reduces QBI from profitable businesses. If total QBI is negative, the loss carries forward to reduce QBI in future years.

Claiming the QBI Deduction

The QBI deduction is reported on:

• Form 8995 (Simplified) - For taxpayers with income below threshold amounts
• Form 8995-A (Standard) - For taxpayers with income above thresholds, SSTBs, or multiple businesses

The deduction flows to Form 1040, Line 13 and reduces taxable income. It is a "below-the-line" deduction that does not affect AGI.

EA Exam Tips

Key points to remember:

1. Memorize the 2024 thresholds: $191,950 / $241,950 (single); $383,900 / $483,900 (MFJ)
2. Know the SSTB list - especially the common ones: health, law, accounting, consulting, financial services
3. Engineers and architects are NOT SSTBs - common exam trap
4. Real estate and insurance brokers are NOT SSTBs - another common distinction
5. The deduction is limited to 20% of taxable income (minus net capital gains) as an overall cap
6. W-2 wage limitation has two options - memorize "50% of W-2" OR "25% W-2 + 2.5% UBIA"
7. REIT/PTP component is separate and not subject to W-2/UBIA limitations
8. C corporation income and employee wages never qualify for the QBI deduction
9. The deduction expires after 2025 unless extended by Congress