For tax years starting in 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) created a new deduction for owners of pass-through business entities, such as sole proprietorships, partnerships, S corporations and limited liability companies (LLCs) that are treated as sole proprietorships, partnerships or S corporations for tax purposes. The deduction, sometimes referred to as Section 199A, generally equals 20% of qualified business income (QBI), subject to limitations that can begin to apply if taxable income exceeds the applicable threshold — $157,500 or, if married filing jointly, $315,000. The limits fully apply when taxable income exceeds $207,500 and $415,000, respectively.
The Section 199A deduction should not be confused with the Section 199 deduction which refers to the domestic production activities deduction or “manufacturers deduction” which was eliminated for tax years beginning after December 31, 2017.
QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.
The QBI deduction isn’t allowed in calculating the owner’s adjusted gross income, but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.
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 the depreciable tangible property (including real estate) owned by a qualified business as of year end and used by the business at any point during the tax year to produce qualified business income. Additional rules apply.
Another limitation for taxpayers subject to the income-based limit is that the QBI deduction generally isn’t available for income from specified service businesses. Examples include businesses that involve investment-type services and most professional practices (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.