Pass-Through Deduction (QBI) Guide for Small Business

What Is the Pass-Through Deduction (Section 199A)?

The Section 199A deduction, commonly called the pass-through deduction or QBI deduction, allows eligible business owners to deduct up to 20% of their qualified business income from their taxable income. Enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017, this provision was made permanent by the American Innovation and Choice Act of 2025. It applies to income from sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs) taxed as pass-through entities.

Unlike self-employment tax, which is a separate payroll tax on net earnings, the QBI deduction reduces your income tax liability at the individual level. It is an "below-the-line" deduction — you claim it on your individual return after calculating adjusted gross income (AGI), whether or not you itemize deductions.

Quick Answer

Eligible small business owners can deduct up to 20% of qualified business income (QBI) from their taxable income. The deduction is limited to the lesser of: (1) 20% of QBI, or (2) 20% of taxable income minus net capital gains. For taxpayers with income above threshold amounts, additional limitations based on W-2 wages and the unadjusted basis of qualified property apply.

Who Qualifies for the QBI Deduction?

The deduction is available to owners of pass-through entities who have qualified business income. Eligible entities include:

• Sole proprietorships (Schedule C filers)
• Partnerships (including LLPs)
• S corporations
• LLCs taxed as any of the above
• Trusts and estates with pass-through income

C corporations do not qualify — the QBI deduction is specifically designed for pass-through business owners to partially offset the corporate tax rate advantage that C corporations enjoy under the TCJA.

What Is Qualified Business Income (QBI)?

QBI is the net amount of income, gain, deduction, and loss from an active trade or business. Several types of income are explicitly excluded from QBI:

• Capital gains and losses
• Dividends and interest income (unless properly allocable to a trade or business)
• Income from foreign sources that is not effectively connected with a US trade or business
• W-2 wages paid to the owner (for S corporation shareholders)
• Guaranteed payments to partners
• Income from specified service trades or businesses (SSTBs) — subject to income-based phase-out

It is critical to distinguish QBI from other types of business income. For example, a real estate business that earns primarily rental income may need to meet the safe harbor requirements under Notice 2019-07 to qualify the rental activity as a trade or business for QBI purposes.

Income Thresholds and Limitations

The QBI deduction operates differently depending on your taxable income level:

Below Threshold (2026)

For taxpayers with taxable income at or below $191,950 (single) or $383,900 (married filing jointly), the deduction is simply 20% of QBI, capped at 20% of taxable income minus net capital gains. The W-2 wage and qualified property limitations do not apply.

Above Threshold — Phase-In Range

For taxpayers with income between the threshold and the upper limit ($241,950 single / $483,900 MFJ), the W-2 wage and qualified property limitations begin to phase in on a prorated basis. The deduction is reduced by the excess of the applicable percentage of W-2 wages and qualified property over the same percentage of QBI.

Above Upper Limit

Taxpayers above the upper limit face the full W-2 wage and qualified property limitations. The deduction is limited to the greater of:

• 50% of W-2 wages paid by the business, or
• 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property

For SSTB owners above the upper limit, the QBI deduction is eliminated entirely.

Specified Service Trades or Businesses (SSTBs)

An SSTB is a trade or business involving the performance of services in one of the following fields:

• Health (doctors, dentists, chiropractors, physical therapists)
• Law (attorneys, paralegals)
• Accounting (CPAs, enrolled agents, bookkeepers)
• Actuarial science
• Performing arts
• Consulting
• Athletics and coaching
• Financial services (investment management, brokerage)
• Architecture and engineering (note: engineering was removed from the SSTB list by regulation)

If your business is an SSTB and your taxable income exceeds the upper limit, you receive no QBI deduction. Within the phase-in range, the deduction is reduced proportionally. Below the threshold, SSTB status does not matter — the full deduction applies.

Architects and engineers should note that the final IRS regulations removed engineering from the SSTB list, meaning engineering firms can claim the QBI deduction regardless of income level. This is a common point of confusion for small business tax deduction planning.

How to Calculate the QBI Deduction

The calculation follows a multi-step process:

Step 1: Determine QBI

Start with net income from your trade or business. Subtract any excluded items (capital gains, guaranteed payments, W-2 wages to the owner). If you have multiple businesses, calculate QBI separately for each.

Step 2: Apply the 20% Rate

Multiply QBI by 20%. This is your preliminary deduction before limitations.

Step 3: Apply Limitations (if applicable)

If your taxable income exceeds the threshold, apply the W-2 wage and qualified property limitations. For each business, calculate the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property. Your deduction for that business cannot exceed this limit, prorated for the phase-in range.

Step 4: Apply the Overall Taxable Income Cap

Your total QBI deduction (across all businesses) cannot exceed 20% of your taxable income minus net capital gains. This is a hard ceiling regardless of how much QBI you have.

Common QBI Deduction Strategies

Small business owners can take several steps to maximize the QBI deduction:

• Pay reasonable W-2 wages — If you operate as an S corporation, paying yourself and employees reasonable wages increases the W-2 wage limitation, which unlocks a larger QBI deduction for higher-income taxpayers
• Aggregate trades or businesses — The IRS allows taxpayers to aggregate related businesses if they meet certain criteria, potentially combining a low-wage/high-QBI business with a high-wage business to increase the overall deduction
• Time income and deductions — Deferring income or accelerating deductions may keep you below the SSTB phase-out threshold in a given year
• Use the safe harbor for rental real estate — Revenue Procedure 2019-38 provides a safe harbor that may allow rental real estate to qualify as a trade or business for QBI purposes

These strategies work alongside other small business tax credits and the Section 179 deduction to reduce your overall tax burden.

Reporting the QBI Deduction

The QBI deduction is reported on your individual tax return (Form 1040). The deduction appears on line 13 of the 2025 Form 1040 as a subtraction from income. Supporting calculations are made on Form 8995 (simplified) or Form 8995-A (detailed), depending on your income level:

• Form 8995 — Use if your taxable income is at or below the threshold ($191,950 single / $383,900 MFJ)
• Form 8995-A — Use if your taxable income exceeds the threshold and you need to calculate the W-2 wage and qualified property limitations

Partnerships and S corporations report QBI and related information on Schedule K-1 (Boxes 20 and 20A), which flows through to the individual owner's return.

Key Takeaways

• The Section 199A QBI deduction allows eligible pass-through business owners to deduct up to 20% of qualified business income
• Income thresholds determine whether the W-2 wage and qualified property limitations apply ($191,950 single / $383,900 MFJ for 2026)
• Specified service trades or businesses (SSTBs) face a complete phase-out of the deduction above the upper income limit
• The deduction is capped at 20% of taxable income minus net capital gains
• Strategic W-2 wage planning, business aggregation, and income timing can help maximize the deduction