The QBI Deduction: How the 20% Pass-Through Deduction Works for Business Owners

What the QBI deduction actually does

Section 199A, introduced by the Tax Cuts and Jobs Act, gives pass-through business owners a deduction equal to 20% of their qualified business income (QBI). It shows up on your personal return, after your business income has passed through to your 1040, as a reduction in taxable income.

If you have $100,000 in net business profit, you might be able to deduct $20,000 — reducing the amount you pay income tax on to $80,000. That’s before any other deductions. It’s on top of the home office, auto, health insurance, retirement, and other write-offs you already take.

20% of your qualified business income, deducted on your personal return. It stacks on top of every other deduction.

Who qualifies

The deduction is available to pass-through business owners: sole proprietors, single-member LLCs taxed as sole props, S-corp owners (on the pass-through portion), and partners in partnerships. C-corporations don’t qualify — their income is taxed at the corporate level before distribution.

Below a specific income threshold, most owners qualify with no restrictions. Above the threshold, two complications arise: the phase-out for specified service businesses, and the wage/property limitation for all businesses.

The three situations

What “qualified business income” means

QBI is your net profit from the business — revenue minus deductible expenses. It does not include:

• W-2 wages you receive from your S-corp (your salary is wage income, not pass-through income)
• Capital gains or losses
• Dividends or interest income
• Reasonable compensation paid to you as an S-corp owner (this is already excluded because it’s W-2 income)

For an S-corp owner, QBI is what flows through the K-1 as your share of business income — not your salary. For a sole prop, it’s your Schedule C net profit.

How it interacts with entity structure

Both sole props and S-corps qualify for the QBI deduction. The deduction isn’t a reason to choose one structure over the other.

However, entity structure affects how much income qualifies:

• Sole prop: 100% of net profit qualifies as QBI (minus the deductible half of SE tax). Straightforward.
• S-corp: Only the pass-through distribution qualifies. The W-2 salary you pay yourself is excluded from QBI. So at a given profit level, an S-corp owner deducting the QBI on a smaller distribution base will get a somewhat smaller QBI deduction than a sole prop at the same profit — but the payroll tax savings from the S-corp typically far outweigh this difference at meaningful income levels.

The specified service business problem

If your business is a specified service trade or business (SSTB) and your taxable income exceeds the threshold, the deduction phases out. For most consultants, attorneys, physicians, therapists, accountants, and financial advisors at higher income levels — the deduction disappears.

The phase-out works like this:

• Below $197,300 (single) / $394,600 (MFJ): Full deduction — no restrictions
• $197,300–$247,300 (single) / $394,600–$494,600 (MFJ): Phase-out range — deduction reduces proportionally
• Above $247,300 (single) / $494,600 (MFJ): Deduction goes to zero

What this means for year-end planning

The QBI deduction is calculated on your tax return — you don’t make a separate election or application. But there are planning decisions that affect the size of the deduction:

• Income level: If you’re in the phase-out range, strategies that reduce taxable income (retirement contributions, health insurance premiums) can pull you back below the threshold and preserve the deduction.
• S-corp salary: Setting your W-2 salary at a defensible-but-reasonable level leaves more income as pass-through, which increases your QBI deduction. An unnecessarily high salary both overpays FICA and reduces QBI.
• Retirement contributions: Contributions to a Solo 401(k) or SEP-IRA reduce your taxable income. For SSTB owners near the phase-out threshold, a large retirement contribution could preserve the QBI deduction — potentially making the retirement contribution “pay” twice in tax savings.

For SSTB owners near the threshold, a retirement contribution can preserve the QBI deduction — making it effectively pay double in tax savings.

The bottom line on QBI

If you’re a sole prop or S-corp with taxable income below $197k (single) or $394k (MFJ), you’re almost certainly taking a meaningful deduction without doing anything special. Confirm with your CPA at tax time that it’s appearing correctly on your return.

If you’re above the threshold — or approaching it — the interaction between entity type, salary, retirement contributions, and the SSTB rules becomes a planning conversation worth having before December 31. That’s when the numbers can still move.