What to Know About a New Business Tax Deduction


The Tax Cuts and Jobs Act added a new tax deduction for pass-through business owners that will continue through 2025. This deduction, known as the Section 199A deduction or the qualifying business income deduction (QBID), allows eligible business owners to deduct up to 20% of their business income from their income taxes. So, for example, if you have $100,000 in pass-through income, you might be able to deduct $20,000. That will potentially reduce your income taxes by $4,400 if you’re in the 22% tax bracket. Since QBID is an excellent opportunity for small business owners to decrease their tax bill, it’s crucial to understand the rules.

Who can claim the pass-through deduction?

To qualify for the Section 199A deduction, you must meet the following criteria:

  1. Own a pass-through business. A pass-through business is any business owned and operated through a sole proprietorship, partnership, S Corporation (S Corp), limited liability company (LLC), or limited liability partnership (LLP). These companies do not pay taxes themselves. Instead, the organization’s profits or losses are “passed through” to the owners who pay taxes at their individual tax rates.
  2. Have qualified business income (QBI). To calculate your QBI, subtract any regular deductions from your total business income. Your income can include any rental income if your rental activity qualifies as a business. It does not include, however, short- and long-term capital gains or losses, dividend income, interest income, wages paid to S Corp shareholders, guaranteed payments to members of a partnership or LLC, or any business income earned outside the United States.
  3. Have taxable income. Before you can calculate your pass-through deduction, you’ll need to determine your total taxable income for the year, which consists of income from all sources. Make sure to subtract any deductions. If you’re taking the standard deduction, you’ll deduct $12,200 if you’re filing single or $24,400 if you’re married filing jointly.

Are there any restrictions?

There are four limitations to keep in mind before calculating your pass-through deduction:

  1. It can’t exceed 20% of your total taxable income. For example, if you’re filing single and earned $100,000 in QBI with no other income, your taxable income would be $87,800 with the standard deduction. So, you can only take a QBID of $17,560, instead of the full $20,000.
  2. Your pass-through deduction will be determined separately for each business you own. However, if you own multiple companies that meet two of the following criteria, you can choose to combine them into one deduction:
  3. You will not receive the QBID when you have a qualified business loss. In other words, if your QBI is $0 or less, you will not be eligible for the pass-through deduction. You will need to carry that loss forward and deduct it from your income in the following year.  
  4. Your earnings and your company’s industry may affect your deduction. If you earn more than $160,725 (filing single) or $321,400 and/or your business is a specified service provider, your Section 199A deduction will be limited based on your share of W-2 wages and your company’s depreciable property.

What is a specified service business?

If you operate a specified service trade or business (SSTB), then your deduction phases out at certain thresholds. This restriction is designed to prevent highly compensated individuals who provide personal services from having their employers reclassify them as independent contractors to take advantage of the Section 199A deduction. The list of SSTBs includes:

  1. Health providers, such as doctors and dentists
  2. Law
  3. Accounting
  4. Actuarial science
  5. Performing arts
  6. Athletics
  7. Financial services
  8. Brokerage services, excluding real estate and insurance
  9. Investment and investment management, excluding property managers
  10. Anyone trading and dealing in securities and commodities
  11. Any business where the principal asset is the reputation or skill of one or more of its owners or employees, such as when you

For specified service providers, the deduction is gradually phased out up to $210,700 (filing single) or $421,400 (married filing jointly). At the top of this range, you’re not eligible to take the deduction at all.

Furthermore, your deduction cannot exceed the greater of

  1. 50% of your share of W-2 wages paid by the business
  2. 25% of your share of W-2 wages paid by the business plus 2.5% of any depreciable property used in the business

So, if your company does not have any employees or own any property, you won’t qualify for the deduction.

How do you calculate the Section 199A deduction?

If you’re filing as single and make $160,725 or below, or you’re married filing jointly and earning $321,400 or below, simply multiply your QBI by 20% and take the maximum possible deduction. If you make more than that threshold, things get significantly more complicated.

If your company is not an SSTB, your maximum deduction will depend on how much above the threshold you are. No matter how much above the wage limit you make, you’ll be restricted, at least partially, by W-2 wages and property. When you’re calculating your deduction, you’ll take the greater of the following two amounts into account:

  1. 50% of your share of W-2 wages paid by the business
  2. 25% of your share of W-2 wages paid by the business plus 2.5% of any depreciable property used in the business

If you’re filing as single and make between $160,726 and $210,725, or you’re married filing jointly and earn between $321,401 and $421,400, take the following steps:

  1. Calculate the full 20% deduction. Multiply your total QBI by 20% to determine what your deduction would be if there were no limitations on how much you could take.
  2. Determine your W-2 wage and depreciable property limitation. Multiply your share of W-2 wages by 50%. Then, multiply your share of W-2 wages by 25% and add 2.5% of your business’s depreciable property. Take the greater of the two amounts.
  3. Calculate your phase-in percentage. If you’re single, the W-2 wage and property limitation is phased in by 2% for every $1,000 you make above $160,725. If you’re married, the restriction is phased in by 1% for every $1,000 you earn over $321,400.
  4. Determine your phase-in amount. To determine how much of the limitation to consider, subtract the limitation amount by your full 20% deduction. Then, multiply the difference by your phase-in percentage.
  5. Calculate your deduction. Subtract your phase-in amount from the full 20% to determine how much you’re allowed to deduct for the Section 199A deduction.

Example: Let’s say you’re single with a QBI of $175,735 and no other income. You also pay one W-2 employee $50,000 per year and don’t own any property.

  1. Your full 20% deduction would be $35,145.
  2. If you were restricted by the full W-2 wage and property limitation, you would only be able to take a deduction of $25,000.
  3. Because you earned $15,000 more than the income threshold, the limitation will be phased in by 30%.
  4. The difference between your full deduction and the limitation is $10,145. Multiply that by 30%. Your phase-in amount is $3,043.50.
  5. Your QBID is $32,101.50.

If you’re filing single and earn more than $50,000 over $160,725, if you’re married filing jointly and make more than $100,000 over $321,400, you’ll be fully subject to the W-2 wage and property limitation. To calculate your deduction, follow these steps:

  1. Calculate the full 20% deduction. Multiply your total QBI by 20% to determine what your maximum allowable deduction would be.
  2. Determine the W-2 wage and property limitation. Multiply your share of W-2 wages by 50%. Then, multiply your share of W-2 wages by 25% and add 2.5% of your business’s depreciable property. Then, take the greater of the two amounts.

For example, you’re married filing jointly with $550,000 of total taxable income. $450,000 of that is your QBI. You pay your employees $150,000 in W-2 wages and own property with a value of $500,000.

  1. Your maximum QBID would be $90,000.
  2. 50% of your share of wages is $75,000. Because you own depreciable property, you’ll also have to calculate that limitation. 25% of your W-2 wages plus 2.5% of your property is $50,000.
  3. Because of the W-2 wage and property limitation, your pass-through deduction is $75,000.

How do specified service providers calculate the pass-through deduction?

To calculate your deduction, take the following steps:

  1. Calculate the full 20% deduction. Multiply your total QBI by 20% to determine your deduction if you were eligible to take the full amount.
  2. Determine your maximum allowable deduction. Multiply your share of W-2 wages by 50%. Then, multiply your share of W-2 wages by 25% and add 2.5% of your company’s depreciable property. Your maximum allowable deduction is the greater of the two.
  3. Calculate your phase-out amount. If you’re single, the Section 199A deduction is phased out by 2% for every $1,000 you make above $160,725. If you’re married filing jointly, the deduction is phased out by 1% for every $1,000 earned above $321,400.

Example: You’re filing single and have $180,725 in total income. Your account business earned $150,000 of that. Your company has one employee, whom you paid $50,000, and does not own any property.

  1. Your full 20% deduction would be $30,000.
  2. Because you have an employee, you can only take up to 50% of their W-2 wages, or $25,000.
  3. You make $20,000 above $160,725, so your phase-out percentage is 40%.
  4. You can take 60% of your maximum allowable amount, or $15,000.

Three things to know before taking the QBID

If you qualify for the pass-through deduction, you don’t have to elect to take it or do anything special – you can just claim it on your income tax return. But, there are three things you should know before taking the deduction:

  1. You can claim it even if you don’t itemize. The Section 199A deduction is a personal deduction taken on Form 1040, whether you itemize or not. But, the pass-through deduction will not reduce your adjusted gross income (AGI).
  2. Accurate financial records can help you correctly calculate your QBI. By keeping precise books and carefully reviewing your receipts and statements, you can appropriately deduct any business-related expenses.
  3. An accountant can help you take full advantage of the deduction. They can ensure you’re accounting for all your income and can review your expenses with you, so you don’t miss an important business-related expenditure.

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