The Tax Cuts and Jobs Act (TCJA) was passed on December 22, 2017 and resulted in complex changes affecting individuals and businesses. To maintain the incentive for individuals to own and operate pass-through entities, the TCJA introduced Section 199A Qualified Business Income (QBI) Deduction. Owners of pass-through business entities are defined as sole proprietorships, partnerships, S Corporations and limited liability companies (LLCs) treated as sole proprietorships or partnerships for tax purposes.
Section 199A Deduction Overview
Under Section 199A, the Qualified Business Income (QBI) Deduction is defined as the net amount of qualified items of income, gain, deduction and loss relating to any U.S. qualified trade or business of the taxpayer. QBI doesn’t include certain investment items, reasonable compensation paid to an owner of an S Corporation for services rendered to the business, or any guaranteed payments to a partner or LLC member for services rendered to the partnership or LLC.
The Section 199A deduction allows eligible owners of pass-through businesses to deduct up to 20% of qualified business income (QBI). The One Big Beautiful Bill Act made the Section 199A QBI deduction permanent, removing the previous expiration after 2025. Eligible taxpayers may also qualify for a deduction related to qualified real estate investment trust (REIT) dividends and publicly traded partnership income. The deduction remains subject to income thresholds and other limitations.
The QBI deduction isn’t allowed in calculating the owner’s Adjusted Gross Income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction though you don’t have to itemize to claim it.
When the income-based limit applies to owners of pass-through entities, the QBI deduction generally can’t exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
Qualified property is depreciable tangible property (including real estate) owned by a qualified business and used by the business to produce qualified business income. Rental real estate owners should also understand the requirements for determining when a rental real estate enterprise may qualify as a trade or business for purposes of Section 199A. Learn more about the Section 199A rental real estate safe harbor.
Taxpayers conducting certain specified services trades or businesses may not qualify for the deduction. Examples include businesses that involve investment-type services and most professional practices such as health, legal and accounting other than engineering and architecture.
The W-2 wage limitation and the service business limitation don’t apply if your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.
Income taxation and owner liability are the main factors that differentiate one business structure from another. Many business owners choose entities that combine pass-through taxation with limited liability, namely limited liability companies (LLCs) and S Corporations, LLCs can’t pay wages to their owners. S Corporations can pay wages to their owners. If they pay bonuses that amount to earnings for the year, they eliminate any QBI deduction. If the pay is considered “reasonable compensation,” they could still claim the deduction.
Maximize Your Section 199A Deduction
At the end of the year your firm may be able to time certain items to your tax advantage. For instance, if your enterprise is in danger of being limited by the 50 percent rule for W-2 wages, it might be beneficial to pay bonuses before year-end. It may also be beneficial to replace subcontractors with employees. Similarly, if a deduction would be lowered due to taxable income limitation, you might recognize more income before the close of the tax year, if possible.
Because the Section 199A deduction interacts with taxable income, wages, business structure, and other tax-planning decisions, business owners should evaluate it as part of their broader federal business tax strategy.
Computing and Claiming the Section 199A Deduction
There have been multiple updates from the IRS to help clarify the complexities of the Section 199 or QBI deduction. The calculation is complex and subject to limitations, but every business owner should consult their tax advisor to determine the appropriate deduction.
Items not included in the calculation are earnings from investments, gains from sales of property, reasonable compensation paid, guaranteed payments from a partnership and W-2 wages paid to an owner of an S Corporation.
The IRS provided guidance to describe how to calculate W-2 wages for purposes of the deduction with three detailed explanations of the methods of calculating applicable W-2 wages in Revenue Procedure 2019-11. The easiest method is to use the total amounts reported in box 1 of all W-2s..
Eligible noncorporate taxpayers may claim a Section 199A deduction generally equal to up to 20% of qualified business income from a partnership, S corporation, sole proprietorship, or other qualifying pass-through business. The One Big Beautiful Bill Act made the QBI deduction permanent. Depending on a taxpayer’s income and circumstances, the deduction may still be subject to limitations involving W-2 wages, qualified property, and specified service trades or businesses.
Taxpayers generally calculate the deduction using IRS Form 8995, Qualified Business Income Deduction Simplified Computation, or Form 8995-A, Qualified Business Income Deduction, depending on their circumstances. Because eligibility and limitations can vary significantly based on income, business structure, wages, qualified property, and the nature of the business, taxpayers should work with a tax advisor when determining their Section 199A deduction.
Section 199A Planning Considerations
While the Section 199A deduction is now permanent, determining eligibility and calculating the available deduction can still be complex. Business owners should consider how entity structure, taxable income, W-2 wages, qualified property, and the nature of the business may affect the deduction.
Real estate owners have additional considerations when determining whether rental activity qualifies as a trade or business. Review LBMC’s guidance on the Section 199A rental real estate safe harbor for additional information.
The tax professionals at LBMC help business owners evaluate Section 199A as part of a broader tax strategy, including entity structure, income planning, deductions, and other federal business tax considerations.
Explore LBMC’s Federal Business Tax services or contact LBMC to discuss how the Section 199A deduction may affect your business and tax planning.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.
