Deductions and Credits · Itemized deductions and QBI

Qualified Business Income Deduction

Section 199A was written to expire with the rest of the 2017 individual provisions, and for seven filing seasons every explanation of it carried that warning. The warning is now wrong. Pub. L. 119-21 § 70105 struck the sunset and, at the same address in the Code, put a minimum deduction there instead — so the subsection read for years as the end date now reads as a floor.

The rule

The deduction, in two limbs. For a taxpayer other than a corporation there is allowed a deduction equal to the lesser of the combined qualified business income amount, or 20 percent of the excess of taxable income over net capital gain (IRC § 199A(a)(1), (2)): the lesser of the combined qualified business income amount or 20 percent of the excess of taxable income over net capital gain — subject to the IRC § 199A(i) minimum^TY2026. The second limb is a ceiling on the whole deduction, and because net capital gain comes out of the base, a taxpayer whose income is mostly investment gain can have real business income and still be capped near zero.

The combined amount. It is the sum of a per-business figure for each qualified trade or business, plus 20 percent of qualified REIT dividends and qualified publicly traded partnership income (IRC § 199A(b)(1)(A), (B)). That second component sits outside the wage and property test entirely.

The per-business figure and its limitation. For each qualified trade or business the amount is for each qualified trade or business, the lesser of 20 percent of its qualified business income or the greater of 50 percent of its W-2 wages, or 25 percent of those wages plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property^TY2026 (IRC § 199A(b)(2)(A), (B)(i), (ii)). The wage-or-wage-and-basis prong is what is meant by “the wage limitation”; the 2.5 percent alternative exists so a capital-intensive business with almost no payroll — rental real estate is the standard example — is not shut out.

Who the deduction belongs to. Section 199A is applied at the partner or shareholder level. A partnership or S corporation computes nothing; each owner takes an allocable share of every qualified item, and is treated as having an allocable share of the entity’s W-2 wages and of the unadjusted basis of its qualified property — wages allocated as wage expense is, basis as depreciation is (IRC § 199A(f)(1)(A)(i)–(iii)). So available to a taxpayer other than a corporation — so to a sole proprietor and to an owner of a partnership or S corporation on their share, but not to a C corporation and not on wages^TY2026.

What is not qualified business income. QBI is the net of qualified items of income, gain, deduction and loss from a qualified trade or business, and excludes REIT dividends and PTP income, counted in the other component (IRC § 199A(c)(1)). Section 199A(c)(3)(B) strips out capital gain and loss of either holding period, dividends, interest not allocable to a trade or business, most § 954(c)(1) items, and annuities not received in connection with the business. Section 199A(c)(4) removes reasonable compensation paid to the taxpayer, IRC § 707(c) guaranteed payments, § 707(a) service payments to the extent regulations provide, and — new for 2026 — any amount for which the § 224(a) qualified tips deduction is allowable^TY2026. A net negative is carried into the next year as a loss from a qualified trade or business (IRC § 199A(c)(2)).

Two exclusions the threshold governs. A qualified trade or business is any trade or business other than a specified service trade or business and other than performing services as an employee (IRC § 199A(d)(1)(A), (B)). The employee exclusion is absolute — no threshold rescues it. a specified service trade or business — health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business whose principal asset is the reputation or skill of its employees or owners, and investing, trading or dealing in securities, partnership interests or commodities — is excluded once income passes the phase-in range^TY2026 The list is borrowed from § 1202(e)(3)(A) with engineering and architecture read out, so those two fields are qualified businesses however large they grow, and § 199A(d)(2)(B) adds investing and investment management, trading, and dealing in securities, partnership interests or commodities.

The threshold. $403,500 on a joint return, $201,775 married filing separately, $201,750 for all other returns — below which the wage and property limitation does not apply at all^TY2026 The statutory figure is the 2018 base amount, doubled for a joint return and indexed since (IRC § 199A(e)(2)(A), (B)) — the section as printed cannot give the current number, and Rev. Proc. 2025-32 § 3.26 supplies it.

The phase-in. Above the threshold, both the wage limitation and the specified service exclusion phase in over a range: the limitation phases in between the threshold and $553,500 joint, $276,775 married filing separately, $276,750 otherwise — a range of $150,000 joint and $75,000 otherwise, doubled from the original by Pub. L. 119-21^TY2026. Within that range the wage limitation is not applied as a cliff. The excess amount — the difference between 20 percent of QBI and the wage-and-property figure — is reduced in the ratio that the taxpayer’s excess over the threshold bears to the width of the range, and only that reduced amount comes off (IRC § 199A(b)(3)(B)(i)–(iii)). A specified service business inside the range keeps only the applicable percentage of its items, wages and basis (IRC § 199A(d)(3)(A)). Above the range it keeps none.

The minimum. the deduction is the greater of the amount otherwise determined or $400, for a taxpayer with at least $1,000 of aggregate qualified business income from active qualified trades or businesses in which they materially participate within IRC § 469(h) — both figures indexed from 2027^TY2026 (IRC § 199A(i)(1), (2), (3)). Material participation is the § 469(h) test, so a passive investor does not qualify for the floor even though the same income is qualified business income for the main computation.

Where it sits on the return. It is not an itemized deduction. Section 63(b)(3) subtracts any § 199A deduction in arriving at taxable income for an individual who does not itemize, alongside the standard deduction — so it is available either way, and it reduces neither adjusted gross income nor self-employment income.

Current figures

How it works in practice

Work the computation as three questions in order, and most of the difficulty disappears.

First: is taxable income at or below the threshold? If it is, IRC § 199A(b)(3)(A) applies the per-business rule without subparagraph (B) — no wage test, no property test, and a specified service business is a qualified business in full. Note which income figure is tested: taxable income, not adjusted gross income and not business income, computed before the § 199A deduction itself.

Second: if it is above, is it above by more than the range? Past the top of the phase-in range the two limitations apply flat. A specified service business is simply not a qualified trade or business, and its income, wages and property drop out altogether. An ordinary business is capped at the greater of 50 percent of W-2 wages, or 25 percent of wages plus 2.5 percent of unadjusted basis in qualified property.

Third: if it is inside the range, apply the ratio. For the wage limitation, the gap between 20 percent of QBI and the wage-and-property figure is the excess amount, and the reduction is that gap multiplied by the fraction of the range already used. For a specified service business, the applicable percentage is one minus that same fraction, applied to income, wages and basis alike.

Two mechanical points cause more errors than the arithmetic. W-2 wages means the amounts reported under § 6051(a)(3) and (8) — so a sole proprietor with no employees has no W-2 wages at all, and an S corporation shareholder’s own reasonable compensation is W-2 wages of the business even though it is excluded from that shareholder’s QBI. And the unadjusted basis is basis immediately after acquisition, unreduced by depreciation, so bonus depreciation costs a taxpayer nothing here.

How this has changed

The change of record is Pub. L. 119-21 § 70105. Section 199A(i) used to say the section would not apply to taxable years beginning after 31 December 2025. That sentence is gone; the subsection now carries the minimum deduction instead, and permanent — the former IRC § 199A(i) sunset for taxable years beginning after 2025 was replaced by Pub. L. 119-21 § 70105 with the minimum deduction, at the same address^TY2026. Anyone working from a 2024 or 2025 explanation is carrying a sunset that no longer exists — a general pattern in the 2025 Act, so any provision an older source describes as expiring after 2025 should be checked at source before it is repeated.

Two substantive changes travelled with the permanence. The phase-in width was doubled: $75,000, or $150,000 on a joint return — raised from $50,000 and $100,000 for taxable years beginning after 31 December 2025^TY2026, which appears in the statutory text of both § 199A(b)(3)(B)(i) and § 199A(d)(3)(A) and in the Rev. Proc. 2025-32 § 3.26 tables. A wider range means the limitation bites more gradually, and taxpayers who were fully phased out in 2025 may be back inside the range in 2026 on unchanged income. The new § 199A(i) minimum deduction takes effect for taxable years beginning after 31 December 2025, with both of its amounts indexed for years beginning after 2026 (IRC § 199A(i)(3)).

One further 2026 change reaches into the definition: § 199A(c)(4) now also excludes from qualified business income any amount for which the § 224(a) deduction for qualified tips is allowable — a tipped proprietor cannot take both on the same dollars.

Exam focus

Expect the threshold to be the hinge of the question. The favourite structure gives a taxpayer plainly below it and asks for the deduction — the answer is 20 percent, with the specified service question a distractor — or gives one plainly above it with a specified service business, where the answer is nothing. The phase-in arithmetic appears less often, but when it does the reduction is applied to the excess amount and not to the deduction.

Know that the deduction is available whether or not the taxpayer itemizes, that it reduces neither adjusted gross income nor self-employment income, and that it belongs to the owner rather than the entity. Know who is outside it entirely: C corporations, and employees on their wages. Be able to say why a sole proprietor with no employees has no W-2 wages, and why that only matters above the threshold. For 2026, know that the section is permanent, that the phase-in width doubled, and that a small active business now has a floor under its deduction.

Check yourself

1. A single taxpayer with taxable income of $140,000 runs a law practice with $110,000 of qualified business income and pays no wages. What is the § 199A deduction, and does the practice being a specified service trade or business matter?

Answer: $22,000, and no. Taxable income is below the threshold, so IRC § 199A(b)(3)(A) applies the per-business rule without the wage and property limitation and § 199A(d)(3)(A) treats the specified service business as qualified in full — subject only to the § 199A(a)(2) ceiling.

2. A partnership pays a partner a $90,000 guaranteed payment for services and pays $200,000 of W-2 wages to its employees. How does the guaranteed payment affect that partner’s qualified business income and the partnership’s W-2 wages for the limitation?

Answer: It reduces the partner’s qualified business income — IRC § 199A(c)(4)(B) excludes a § 707(c) guaranteed payment — and does nothing for the wage limitation, because a guaranteed payment is not a W-2 wage under § 6051(a) and is not in the $200,000. The partner loses on both sides.

3. Why can a rental real estate business with a single part-time employee still claim a substantial deduction above the threshold?

Answer: Because IRC § 199A(b)(2)(B)(ii) offers the alternative of 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of all qualified property, and the taxpayer takes the greater of that and 50 percent of wages. A capital-intensive business with little payroll is carried by the basis component, which depreciation does not reduce.

4. A married couple filing jointly have $3,000 of qualified business income from a craft business in which they both materially participate, and taxable income well below the threshold. What is their deduction?

Answer: $600 by the ordinary computation, but IRC § 199A(i) makes it $400 or the computed amount, whichever is greater — so $600 stands. The floor would apply only if 20 percent of QBI came to less than $400, which needs QBI below $2,000; they clear the $1,000 applicable-taxpayer test either way.

5. A taxpayer’s only business income is $40,000 of qualified publicly traded partnership income. The partnership reports no allocable W-2 wages. Does the wage limitation reduce the deduction?

Answer: No. Qualified publicly traded partnership income enters the combined qualified business income amount through IRC § 199A(b)(1)(B) at a flat 20 percent, outside the § 199A(b)(2) per-business computation where the wage and property limitation lives. Qualified REIT dividends are treated the same way.