QBI Deduction: How the 20% Pass-Through Deduction Works (2025-2026)

You run a business as a sole proprietor and net $150,000. Before the QBI deduction, the full $150,000 is taxable income. After applying Section 199A, you may deduct $30,000 --- dropping your taxable income to $120,000 and saving you roughly $7,200 in federal taxes at the 24% bracket. That is the qualified business income deduction in action.

Key Takeaways

• Pass-through business owners can deduct up to 20% of qualified business income.
• The deduction is available to sole proprietors, S-corp shareholders, partners, and some trust beneficiaries.
• Specified service trades and businesses (SSTBs) face income-based phase-outs.
• Above the income thresholds, non-SSTB businesses must pass W-2 wage or property tests to claim the full deduction.
• The QBI deduction expires after 2025 unless Congress extends the TCJA.

What Is the QBI Deduction?

Section 199A of the Internal Revenue Code allows owners of pass-through entities to deduct up to 20% of their qualified business income (QBI). Pass-through entities include:

• Sole proprietorships (Schedule C)
• S-corporations (Schedule K-1)
• Partnerships and LLCs taxed as partnerships (Schedule K-1)
• Trusts and estates with pass-through income

The deduction is taken on your individual return (Form 1040, line 13) and does not require itemizing. It reduces taxable income but not adjusted gross income (AGI) or self-employment tax.

QBI includes the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business. It does not include W-2 wages, capital gains, interest, or dividend income.

How to Calculate the QBI Deduction

Simplified calculation (below income thresholds):

If your taxable income before the QBI deduction is below the threshold, the deduction is simply the lesser of:

1. 20% of your QBI, or
2. 20% of your taxable income (minus net capital gains)

Full calculation (above income thresholds):

Once your income exceeds the thresholds, the deduction is the lesser of:

1. 20% of QBI, or
2. 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

This is where the W-2 wage and property tests (discussed below) become critical.

Income Thresholds (2025)

The QBI deduction phases in limitations once your taxable income exceeds certain thresholds. These thresholds are adjusted for inflation each year.

The 2025 thresholds above are from IRS Rev. Proc. 2024-40. The QBI deduction is scheduled to expire after 2025 if the TCJA is not extended, so 2026 thresholds may not apply.

Below the lower threshold, you get the full 20% deduction regardless of business type. Between the thresholds, limitations phase in. Above the upper threshold, SSTB income is fully excluded and non-SSTB income must satisfy the wage/property tests.

Specified Service Trades and Businesses (SSTBs)

An SSTB is a business where the principal asset is the reputation or skill of its employees or owners. The IRS specifically lists:

• Health care (doctors, dentists, nurses, pharmacists)
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services and brokerage
• Any business where the principal asset is the reputation or skill of employees/owners

Architecture and engineering are explicitly excluded from the SSTB definition --- they qualify for the full QBI deduction at any income level (subject to wage/property tests).

If your taxable income is below the threshold, the SSTB classification does not matter --- you still get the full deduction. Above the phase-out range, SSTB owners get zero QBI deduction.

The W-2 Wage and Property Tests

For non-SSTB businesses above the income threshold, you must pass one of two tests:

Test 1 --- 50% of W-2 wages: Your QBI deduction is limited to 50% of W-2 wages paid by the qualified business.

Test 2 --- 25% of wages + 2.5% of property: Your deduction is limited to 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property held at year-end.

You use whichever test produces the larger deduction. This is why many high-income sole proprietors consider an S-corp election --- paying yourself W-2 wages creates the wage base needed to support a larger QBI deduction.

QBI for Sole Proprietors vs. S-Corp Owners

Factor	Sole Proprietor	S-Corp Owner
QBI source	Schedule C net profit	K-1 ordinary business income
W-2 wages for wage test	$0 (no payroll)	Salary paid to shareholder-employee
SE tax on QBI	Yes (full net profit)	No (only on salary)
Maximizing QBI deduction	Limited above threshold (no wages)	Salary creates W-2 wage base

For a sole proprietor earning well above the threshold, the lack of W-2 wages can shrink or eliminate the QBI deduction. Converting to an S-corp and paying a reasonable salary creates the wage base to support the deduction. See our S-corp tax strategies guide and QBI + S-corp optimization guide for detailed comparisons.

Worked Examples

Example 1 --- Below threshold: Alex is a single freelance designer with $100,000 of QBI and $95,000 of taxable income (after the standard deduction). Since $95,000 is below the $197,300 threshold, Alex deducts 20% x $95,000 = $19,000 (limited by taxable income, not QBI).

Example 2 --- Above threshold, non-SSTB: Sam and Pat (MFJ) own a manufacturing LLC earning $500,000 in QBI. The business pays $200,000 in W-2 wages and has $1,000,000 in qualified property (UBIA). Their taxable income of $500,000 exceeds the $494,600 upper threshold.

• 20% of QBI = $100,000
• 50% of W-2 wages = $100,000
• 25% of wages + 2.5% of property = $50,000 + $25,000 = $75,000
• Deduction = lesser of $100,000 and the greater of ($100,000, $75,000) = $100,000

Example 3 --- SSTB above threshold: Dr. Lee is a single physician with $300,000 of QBI. Since taxable income exceeds $247,300, and medicine is an SSTB, the QBI deduction is $0.

QBI and Passive Activity Rules

The QBI deduction and the passive activity loss rules are separate calculations, but they interact. Passive income from a qualified trade or business (such as a rental activity that qualifies as a trade or business, or a partnership where you are a passive investor) can still generate QBI. However, passive losses that are suspended under Section 469 reduce QBI in the year they are allowed --- not the year they are incurred. If you have both passive and non-passive businesses, each activity’s QBI is calculated separately.

TCJA Sunset Risk

The QBI deduction was introduced by the Tax Cuts and Jobs Act of 2017 and is currently set to expire after December 31, 2025. If Congress does not extend or make it permanent, pass-through business owners will lose this deduction entirely starting in tax year 2026.

This is one of several major TCJA provisions at risk. See our TCJA sunset guide for the full picture. If the QBI deduction does expire, strategies like maximizing retirement contributions, S-corp salary optimization, and shifting income timing become even more important for self-employed tax planning.

How sharper.tax Helps

sharper.tax analyzes your uploaded return to calculate your QBI deduction and identify whether you are leaving money on the table. We flag SSTB classification, test the wage and property limits, and model how structural changes --- like an S-corp election --- could increase your deduction.

Sources

• IRC Section 199A --- Qualified Business Income
• IRS Form 8995 and Instructions
• IRS Publication 535 --- Business Expenses (Chapter on QBI)
• IRS FAQs on Qualified Business Income Deduction

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The information above is educational and not tax advice.