11.3 Entity Selection: Reasonable Comp & QBI
Key Takeaways
- Reasonable Compensation: 5-factor Elliotts test.
- QBI (§199A): 20% deduction — made PERMANENT by OBBBA.
- Tax Year 2025 QBI thresholds: $197,300 (Single/HOH) / $394,600 (MFJ).
- SSTB phase-out: complete at $247,300 (Single) / $494,600 (MFJ) for 2025 (TCJA $50K/$100K ranges).
- OBBBA 2026 changes (context): wider $75K/$150K phase-in plus new $400 minimum QBI deduction for taxpayers with ≥ $1,000 QBI.
- S-Corp: SE tax savings but reasonable salary required.
- C-Corp: tax-free fringe benefits for shareholder-employees + 21% permanent rate + expanded §1202 QSBS.
- Choice-of-entity calculus under OBBBA: 21% flat + §1202 ($15M cap, tiered 50%/75%/100% holding) vs. permanent 20% QBI.
Why This Matters for the Exam
Reasonable Comp and QBI are heavy exam topics. Know the Tax Year 2025 thresholds, SSTB rules, and the post-OBBBA permanence of both the 21% corporate rate and the §199A QBI deduction — these together reshape entity selection.
Expect at least 3-4 questions on entity selection.
Reasonable Compensation (5 Factors)
| Factor | Description |
|---|---|
| 1. Role | What does owner do? (Hours, responsibilities) |
| 2. External comparison | What would non-owner be paid? |
| 3. Company condition | Size, complexity, profitability |
| 4. Conflict of interest | Is salary a tax avoidance tool? |
| 5. Internal consistency | Compare to other executives |
QBI Deduction (§199A) — Tax Year 2025 (Permanent under OBBBA)
| Filing Status | Threshold (Start) | Fully Phased Out (SSTB) |
|---|---|---|
| Single / HOH | $197,300 | $247,300 |
| MFJ | $394,600 | $494,600 |
The 2025 phase-in ranges remain the TCJA values: $50,000 (Single/HOH) and $100,000 (MFJ). OBBBA made §199A permanent and, starting 2026, widens those ranges to $75,000 / $150,000 and adds a $400 minimum deduction for taxpayers with at least $1,000 of qualified QBI — useful context but not the 2025 rule.
SSTB (Specified Service) Treatment — 2025
| Income Level | SSTB Deduction |
|---|---|
| Below threshold ($197,300 / $394,600) | Full 20% |
| In phase-out range | Partial |
| Above phase-out ($247,300 / $494,600) | $0 |
S-Corp vs. C-Corp Fringe Benefits
| Benefit | S-Corp (>2% owner) | C-Corp |
|---|---|---|
| Health insurance | Included in W-2 | Tax-free |
| Group life (≤ $50k) | Included in W-2 | Tax-free |
| Educational assistance | Limited | Tax-free ($5,250, permanent under OBBBA, includes student-loan payments) |
C-Corp vs. Pass-Through Under OBBBA — The 2025 Calculus
OBBBA fundamentally changes choice-of-entity by making BOTH sides of the trade-off permanent:
| Lever | C-Corporation | Pass-Through (S-Corp / Partnership / LLC) |
|---|---|---|
| Entity rate | 21% flat — permanent (OBBBA) | None at entity (owner brackets up to 37%) |
| §199A QBI | N/A | 20% deduction — permanent (OBBBA) |
| Double taxation | Yes (corp + dividend 0/15/20%) | No |
| §1202 QSBS exclusion | Expanded by OBBBA for stock acquired AFTER July 4, 2025: cap raised to $15M (or 10× basis), asset test raised to $75M, and a tiered holding period — 50% at 3 yrs / 75% at 4 yrs / 100% at 5 yrs. Pre-OBBBA stock keeps the old $10M / $50M / 5-year 100% rules. | Not available |
| Fringe benefits | Tax-free to shareholder-employees | Limited (>2% S-corp owners) |
| SSTB QBI cliff | N/A | Yes (above $247,300 / $494,600) — favors C-corp for high-income SSTBs |
Practical implication: A founder planning a high-growth, equity-funded business who can hold qualified stock 3+ years now has a stronger §1202 case for C-corp than under pre-OBBBA law. A profitable service partnership or single-owner LLC below the QBI threshold typically still favors pass-through because the permanent 20% §199A deduction stacks on top of individual rates without the second layer of dividend tax.
Real-World Scenario
Scenario: MFJ accounting firm (SSTB) with $500,000 taxable income in 2025.
- Threshold: $394,600.
- Fully phased out: $494,600.
- $500,000 > $494,600
- QBI deduction: $0 (SSTB fully phased out).
On the Exam
Expect 3-4 questions on selection, typically:
- Threshold Questions: "MFJ QBI threshold for 2025?" ($394,600)
- SSTB Questions: "$500,000 SSTB income — QBI deduction?" ($0)
- Reasonable Comp Questions: "What triggers Elliotts test?"
- OBBBA Questions: "§1202 QSBS cap for stock acquired after 7/4/2025?" ($15M / 10× basis)
The key is to remember: QBI = 20%, permanent. 2025 MFJ threshold = $394,600. SSTB above $494,600 = $0. S-Corp = salary required. C-Corp = 21% permanent + tax-free fringes + expanded §1202.
MFJ accounting firm (SSTB), $500,000 taxable income in 2025. QBI deduction?
Tax Year 2025 QBI threshold for Single filers (post-OBBBA)?
Which entity offers tax-free health insurance to shareholder-employees?