Maximizing the QBI Deduction: How Business Owners Can Qualify and Optimize Tax Savings

The qualified business income (QBI) deduction – aka the Section 199A deduction – was created by the Tax Cuts and Jobs Act of 2017 (TCJA) to offer tax savings strategies to certain pass-through entities. The deduction allows eligible sole proprietorships, partnerships and S corporations (and some trusts and estates) to deduct up to 20% of their qualified business income, lowering federal taxable income and saving money at tax time.  

Before claiming the deduction, it's important to understand what counts as qualified business income and who qualifies: The deduction can be reduced or eliminated if your company is an SSTB (specified service trade or business) or you exceed IRS income thresholds or W-2 wage limits. Here's what you need to know.  

Quick Facts:  

• Qualified business income (QBI) is the net amount of a business's income, deductions, losses and gains, excluding wages, compensation received by S corporation shareholders and investment income unrelated to the business.¹  
• The QBI deduction lets eligible pass-through businesses, including LLCs and S corporations, deduct up to 20% of their QBI plus 20% of qualified real estate investment trust (REIT) dividends.²  
• The QBI deduction can be reduced or eliminated depending on your total taxable income and the nature of the business.
• The QBI deduction provides temporary tax relief to certain pass-through business owners; the deduction is set to expire at the end of 2025 unless it's extended.  

Understanding the QBI Deduction

What is Qualified Business Income (QBI)?

Knowing what counts as qualified business income is helpful before digging into the QBI deduction. According to the IRS, QBI is "the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business."³ That includes the deductible portion of self-employment tax, self-employed health insurance, contributions to qualified retirement plans and unreimbursed partnership expenses.⁴

Some items are excluded from QBI, including:

• Investment income, such as capital gains and losses
• Certain dividends
• Annuities
• Interest income that isn't allocable to the trade or business
• Commodities or forex gains and losses
• Reasonable compensation paid to S corporation shareholders
• Guaranteed payments to LLC members or partners in partnerships  
• Business income generated outside of the U.S.⁵  

Which Types of Businesses Can Claim the QBI Deduction?  

The QBI deduction is only available to owners of businesses operating as pass-through entities (where business income "passes through" to the owners' personal tax returns), including:⁶

• Sole proprietorships
• LLCs
• Partnerships
• S corporations
• Estates and trusts

The TCJA handed corporations their own tax break – a permanently reduced flat-rate corporate income tax rate of 21% – so these entities are ineligible for the QBI deduction.  

Eligibility Requirements

The QBI deduction is intended to benefit small businesses. As such, the deduction has income limits that determine whether you can take the full 20% deduction, a partial deduction or none at all. Also at play is whether your business is a specified service trade or business (SSTB) – one that provides a service rather than a product, including fields like: ⁷

• Health
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services
• Investing and investment management  
• Trading and dealing
• Brokerage services
• Any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees

You can claim the full 20% QBI deduction if your total taxable income falls below the taxable income threshold, whether you're an SSTB or non-SSTB. At higher income levels, SSTBs can claim a partial deduction – or none at all above certain limits above the phase-in range. Here are the QBI income limits for 2024⁸ and 2025:⁹

For non-SSTBs where the owner's taxable income exceeds the threshold, the QBI deduction is partially or fully reduced to the greater of:

• 50% of the business's W-2 wages paid; or  
• 25% of W-2 wages plus 2.5% of the UBIA – the basis in business-owned property.¹⁰

Strategies to Qualify for the QBI Deduction

Entity Structure Optimization

Only pass-through entities – including sole proprietorships, LLCs and S corps – can claim the QBI deduction. Sole proprietorships offer simplicity but not the liability protection that LLCs and S corps offer. S corps come with added tax perks, avoiding the double taxation that regular corporations face and enjoying significant savings on self-employment taxes.  

As an S corp, you must pay shareholders a "reasonable" salary, which is subject to the 15.3% self-employment tax ("reasonable" generally means what other employers would pay for the same or similar services).¹¹ These payments are excluded from QBI, reducing the deduction you can claim. For example, if your business makes $100,000 and you pay yourself a $50,000 salary, you can claim the QBI deduction only on the remaining $50,000.  

However, any remaining business profits can be paid out as distributions. These are subject to ordinary income tax rates – but not the 15.3% self-employment, saving you money. You can save even more by claiming the QBI deduction on the distribution when you file your tax return.  

Managing Taxable Income

Owners of SSTBs need to stay below the phase-out threshold to claim the QBI deduction. Here are a few strategies for managing your taxable income:

• Contribute the maximum to tax-advantaged retirement plans (i.e., SEP IRAs, SIMPLE IRAs)
• Max out your health savings account (HSA) contributions.
• Make charitable contributions.
• Defer income until the next tax year if you expect to be in a lower tax bracket.
• Prepay expenses (like rent, utilities and supplies) to lower taxable income for the current year.  

Documentation and Compliance

For high-income earners, the QBI deduction is subject to certain limitations based on W-2 wages paid and the unadjusted basis of qualified property. As such, tracking these items is essential if you want to maximize your QBI deduction and ensure compliance with IRS rules. Here are a few tips to keep in mind:  

• Review your payroll systems to ensure accurate W-2 reporting.
• Maintain clear records of acquisition costs and depreciation schedules for qualified property.
• Consult a tax professional, especially if you're near phase-out thresholds, have complex asset structures or receive REIT dividends.  

Common Pitfalls and How to Avoid Them

Misclassifying SSTBs

The line between SSTBs and non-SSTBs isn't always clear, but it matters for the QBI deduction. For example, a company offering IT solutions may claim to be a tech firm (non-SSTB), while its primary revenue comes from consulting services – making in an SSTB. It's important to focus on the specific services you offer that generate income when determining whether you're an SSTB or non-SSTB.  

Underpaying S-Corp Salaries

If an S corp doesn't pay a reasonable salary to shareholder-employees, the IRS can reclassify distributions as wages, leading to back taxes, interest and penalties. To avoid this, owners should pay fair compensation based on duties, industry standards and business profits before taking distributions.

Overlooking State-Level Rules

Some states fully conform to federal tax laws, allowing the QBI deduction, while others partially conform or don't allow it at all. For example, California¹² does not allow the deduction, while Oregon allows a reduced tax rate for QBI.¹³ Rules can also differ based on business type and may change annually, so it's crucial to check state-specific guidelines regularly.  

Working with a Financial Advisor

The QBI deduction can be complex due to factors like income thresholds, business classifications, W-2 wage limits and varying state rules. Navigating these details correctly is essential for maximizing the deduction and avoiding costly mistakes. Working with a tax professional and financial advisor can help ensure you optimize your tax strategy and comply with federal and state regulations.

Bottom Line

The QBI deduction is a valuable tax benefit, so it pays to identify ways to maintain your eligibility while maximizing the deduction you can claim. Consider working with financial experts who can help you navigate the complex rules to take full advantage of the tax benefit.

Investment advisory and financial planning services offered through Summit Financial, LLC, an SEC Registered Investment Adviser, doing business as Conway Wealth Group (4 Campus Drive, Parsippany NJ 07054. Tel. 973-285-3600). Neither Summit Financial nor Conway Wealth Group provide tax advice. 7659519.1

1. Congressional Research Service. “The Section 199A Deduction: How It Works and Illustrative Examples.” Jan. 23, 2024.  
2. IRS. “Qualified Business Income Deduction.”  
3. IRS. “Qualified Business Income Deduction.”  
4. IRS. “Tax Cuts and Jobs Act (TCJA) Qualified Business Income Deduction.”  
5. IRS. “Tax Cuts and Jobs Act (TCJA) Qualified Business Income Deduction.”  
6. Tax Policy Center. “What are pass-through businesses?”  
7. IRS. “Tax Cuts and Jobs Act, Provision 11011 Section 199A – Qualified Business Income Deduction FAQs.”  
8. IRS. “2024 Instructions for Form 8995-A; Deduction for Qualified Business Income.”  
9. IRS. “Rev. Proc. 2024-40.”  
10. IRS. “2024 Instructions for Form 8995-A; Deduction for Qualified Business Income.”  
11. IRS. “S Corporation compensation and medical insurance issues.”  
12. State of California Franchise Tax Board. “Partner’s Share of Income, Deductions, Credits, etc.”  
13. Oregon.gov. “Qualified business income reduced tax rate (QBIRTR).”

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