Jessica I. Marschall, CPA, ISA AM

January 2026

Executive Summary

The Qualified Business Income (QBI) deduction under Internal Revenue Code Section 199A represents one of the most significant tax benefits available to owners of pass-through entities. Originally enacted as part of the Tax Cuts and Jobs Act (TCJA) in December 2017, this provision was designed to provide tax parity between pass-through businesses and C corporations, which benefited from a dramatic reduction in the corporate tax rate from 35% to 21%.

While the deduction offers substantial tax savings—allowing eligible taxpayers to deduct up to 20% of their qualified business income—it is subject to complex limitations that phase in based on the taxpayer’s taxable income. For higher-income taxpayers, these limitations can significantly reduce or eliminate the deduction unless strategic planning measures are implemented.

This article provides a comprehensive analysis of the QBI deduction, its income-based phase-out provisions, and (critically) the planning strategies that S corporation owners can employ to maximize their deduction through strategic wage payments and qualified property acquisitions. With the permanent extension of Section 199A under the One Big Beautiful Bill Act (OBBBA) signed into law on July 4, 2025, these planning considerations now carry long-term significance for pass-through entity owners.

Historical Background: The Birth of Section 199A

The Tax Cuts and Jobs Act of 2017

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), the most comprehensive tax reform legislation in over three decades. Among its many provisions, the TCJA dramatically reduced the corporate income tax rate from a graduated structure with a top rate of 35% to a flat rate of 21%, which was the largest single reduction in corporate taxation in U.S. history.

This reduction, while benefiting C corporations and their shareholders, created a significant disparity for pass-through entities. Prior to the TCJA, pass-through income was generally taxed at rates ranging from 10% to 39.6%. While the TCJA reduced the top individual rate to 37%, the gap between corporate taxation (21%) and pass-through taxation (up to 37%) remained substantial.

To address this imbalance and maintain the traditional preference for pass-through taxation, Congress created Section 199A housing the qualified business income deduction. This provision allows eligible non-corporate taxpayers to deduct up to 20% of their qualified business income, effectively reducing the maximum tax rate on pass-through income from 37% to 29.6%.

The Temporary Nature of TCJA Individual Provisions

Due to the budgetary constraints of the reconciliation process used to pass the TCJA, which allowed the legislation to pass the Senate with a simple majority vote rather than the typical 60-vote threshold, many individual provisions, including Section 199A, were enacted as temporary measures. The QBI deduction was originally scheduled to expire for tax years beginning after December 31, 2025.

This sunset provision created significant uncertainty for business owners and their advisors, making long-term tax planning challenging. Business structuring decisions, compensation strategies, and asset acquisition timing all depended on whether Congress would extend or modify Section 199A before its expiration.

The One Big Beautiful Bill Act: Making the QBI Deduction Permanent

The uncertainty surrounding Section 199A ended on July 4, 2025, when President Trump signed the One Big Beautiful Bill Act (OBBBA) into law. This landmark legislation addressed the scheduled sunset of numerous TCJA provisions and introduced several modifications to the QBI deduction framework.

Key OBBBA Changes to Section 199A

Permanent Extension: The OBBBA removed the December 31, 2025 expiration date from IRC §199A(i), making the 20% QBI deduction a permanent feature of the tax code. This provides long-term certainty for business owners and enables meaningful multi-year tax planning strategies.

For 2025 (current TCJA thresholds):

• Married Filing Jointly: $394,600
• Single/Other Filers: $197,300

Phase-in ranges (2025):

• MFJ: $394,600 to $494,600 (a $100,000 range)
• Single: $197,300 to $247,300 (a $50,000 range)

For 2026 and beyond (under OBBBA):

• The thresholds remain similar but with expanded phase-in ranges:
  • MFJ: Approximately $400,000 to $550,000 (now a $150,000 range)
  • Single: Approximately $200,000 to $275,000 (now a $75,000 range)

Below the threshold, you get the full 20% QBI deduction without any wage or property limitations. Within the phase-in range, the limitations gradually apply. Above the range, the W-2 wage and qualified property limitations are fully in effect.

Expanded Phase-In Ranges: Beginning with tax years starting after December 31, 2025, the OBBBA expands the income ranges over which the W-2 wage and qualified property limitations phase in:

• For married filing jointly: The phase-in range increases from $100,000 to $150,000 above the threshold amount
• For all other filers: The phase-in range increases from $50,000 to $75,000 above the threshold amount
• These expanded ranges are indexed for inflation beginning in 2027

Increased Upper Threshold for Joint Filers: The OBBBA raises the upper income threshold for joint filers by $50,000, providing additional room before the full wage and property limitations apply.

Minimum Deduction Provision: A new minimum QBI deduction of $400 is guaranteed for any taxpayer with at least $1,000 in aggregate qualified business income from active qualified trades or businesses in which the taxpayer materially participates. Both amounts are indexed for inflation beginning in 2027.

Comparative Income Thresholds: TCJA vs. OBBBA

Filing Status	2025 Threshold	2025 Phase-In Range	2026+ Phase-In Range (OBBBA)
Married Filing Jointly	$394,600	$394,600 – $494,600	~$400,000 – $550,000
Single/Other	$197,300	$197,300 – $247,300	~$200,000 – $275,000

Note: 2026+ figures are approximate and subject to inflation adjustments.

Understanding the QBI Deduction Mechanics

Basic Calculation Framework

At its core, the QBI deduction allows eligible taxpayers to deduct up to 20% of their qualified business income from domestic pass-through entities. The deduction is claimed on the individual’s Form 1040 and reduces taxable income (but not adjusted gross income). The deduction is available regardless of whether the taxpayer itemizes deductions or claims the standard deduction.

The calculation involves two primary components:

1. QBI Component: 20% of qualified business income from each qualified trade or business, subject to potential limitations based on W-2 wages and qualified property.
2. REIT/PTP Component: 20% of qualified REIT dividends and qualified publicly traded partnership income (not subject to wage or property limitations).

The total QBI deduction cannot exceed 20% of the taxpayer’s taxable income, calculated before the QBI deduction and excluding net capital gains and qualified dividends.

What Constitutes Qualified Business Income

Qualified business income is defined as the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business conducted within the United States. Importantly, QBI does not include:

• Reasonable compensation paid to S corporation shareholder-employees
• Guaranteed payments to partners for services rendered
• Investment income, including capital gains, dividends, and interest not allocable to the trade or business
• Income from notional principal contracts
• Wage income earned as an employee

The Income Phase-Out: Understanding the Limitations

Three-Tier Income Structure

The application of QBI deduction limitations depends entirely on the taxpayer’s taxable income level. The law creates three distinct tiers:

Tier 1 – Below Threshold: Taxpayers with taxable income below the threshold amount ($394,600 for married filing jointly; $197,300 for other filers in 2025) receive the full 20% QBI deduction without application of any limitations. Neither the W-2 wage/qualified property limitation nor the specified service trade or business (SSTB) exclusion applies.

Tier 2 – Within Phase-In Range: Taxpayers with taxable income within the phase-in range experience a proportional phase-in of the limitations. Both the W-2 wage/qualified property limitation and the SSTB exclusion are partially applied based on where the taxpayer falls within the range.

Tier 3 – Above Phase-In Range: Taxpayers with taxable income above the phase-in range are subject to the full W-2 wage/qualified property limitation. Additionally, taxpayers operating SSTBs receive no QBI deduction whatsoever for that business income.

Special Considerations for Specified Service Trades or Businesses

What is an SSTB you ask? Unfortunately, as I write this I identify as one of the IRS enumerated fields falling under the Specified Service Trade or Business.

• Health (physicians, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals)
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services (managing wealth, advising clients on finances, developing retirement plans, etc.)
• Brokerage services
• Any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners (this includes income from endorsements, licensing of an individual’s likeness, or appearance fees)

Notable Exclusions:

• Architecture and Engineering were specifically excluded from the SSTB definition, so these professionals can claim the full QBI deduction regardless of income level. They must have had better lobbyists than the accountants and lawyers.
• Also note how these align with Section 1202 QSBS companies. And note that creating intangible assets such as software assets are NOT excluded from SSTB and QSBS treatment so it is a great time to invent and manufacture intangible software assets.

Why It Matters: For taxpayers with income above the phase-in range, SSTB income receives zero QBI deduction. Within the phase-in range, the deduction is partially reduced. Below the threshold, SSTB status doesn’t matter—you get the full 20% deduction.

There’s also a de minimis exception: A business with gross receipts under $25 million isn’t classified as an SSTB if 10% or less of its gross receipts come from specified service activities.

The W-2 Wage and Qualified Property Limitation

For taxpayers with income above the threshold amount, the QBI deduction is limited to the greater of:

1. 50% of W-2 wages paid by the qualified trade or business, OR
2. 25% of W-2 wages paid by the qualified trade or business, PLUS 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property

This limitation mechanism is critical to understand because it directly connects the available QBI deduction to either the wages the business pays or its investment in depreciable assets. A business with no employees and no qualified property would receive no QBI deduction at all once the taxpayer’s income exceeds the phase-in range.

Defining W-2 Wages for QBI Purposes

For purposes of the Section 199A limitation, W-2 wages include:

• Total wages subject to income tax withholding as reported on Forms W-2
• Elective deferrals to retirement plans (401(k), SIMPLE, etc.)
• Designated Roth contributions
• Deferred compensation amounts

Importantly, wages paid by an S corporation to its shareholder-employees count toward this limitation, even though those wages do not constitute QBI. This creates a powerful planning opportunity, as we will explore below.

Defining Qualified Property (UBIA)

Qualified property for purposes of the 2.5% UBIA calculation includes tangible, depreciable property that:

• Is held by and available for use in the qualified trade or business at the close of the tax year
• Is used by the qualified trade or business at any point during the tax year in the production of QBI
• Has not reached the end of its depreciable period as of the close of the tax year

The UBIA is generally the original cost of the property as of the date it was placed in service—not the adjusted basis after depreciation. Under a special rule, all qualified property has a minimum depreciable period of ten years, regardless of the asset’s actual recovery period under MACRS. This means property remains “qualified” for at least ten years from the date placed in service.

Key Point: Land does not qualify because it is not depreciable. However, buildings, equipment, machinery, furniture, fixtures, and other tangible depreciable assets all qualify.

Strategic Planning: Maximizing QBI Through Wages and Asset Procurement

For S corporation owners whose income exceeds the threshold amount, strategic planning around W-2 wages and qualified property acquisitions can mean the difference between claiming a substantial QBI deduction and receiving no deduction at all. The following strategies should be carefully considered in consultation with qualified tax advisors.

Strategy 1: Optimizing Shareholder-Employee Compensation

Historically, S corporation tax planning often focused on minimizing W-2 wages paid to shareholder-employees while still maintaining a “reasonable compensation” level to satisfy IRS requirements. This strategy reduced employment taxes (Social Security and Medicare) on the portion of income taken as distributions rather than wages. See our earlier article on this subject here: IRS Reasonable Compensation Requirements for S Corporations

The introduction of Section 199A fundamentally changed this calculus for higher-income taxpayers. Since the QBI deduction for those above the threshold is limited based on W-2 wages, paying higher wages can actually result in greater overall tax savings when the increased QBI deduction exceeds the additional employment taxes incurred.

Illustrative Example: The W-2 Wage Trade-Off

Consider an S corporation with $500,000 in net income before shareholder compensation. The sole shareholder is married filing jointly with total taxable income well above the phase-in range.

Scenario A: Minimum Reasonable Compensation

• W-2 wages paid: $100,000
• QBI (remaining pass-through income): $400,000
• Potential QBI deduction (20% × $400,000): $80,000
• W-2 wage limitation (50% × $100,000): $50,000
• Actual QBI deduction allowed: $50,000

Scenario B: Increased Shareholder Compensation

• W-2 wages paid: $180,000
• QBI (remaining pass-through income): $320,000
• Potential QBI deduction (20% × $320,000): $64,000
• W-2 wage limitation (50% × $180,000): $90,000
• Actual QBI deduction allowed: $64,000 (full amount—not limited)

The additional $80,000 in wages results in approximately $12,240 in additional Medicare and Social Security taxes (15.3% on the first $22,500 up to the Social Security wage base, plus 2.9% Medicare on the remainder). However, the additional QBI deduction of $14,000 reduces federal income tax by approximately $5,180 at the 37% marginal rate.

While this simplified example suggests the increased wages may not be beneficial on a pure cash basis, the analysis becomes more favorable when:

• The business has multiple shareholder-employees, spreading employment taxes across more individuals
• Wages are already above the Social Security wage base, eliminating the 12.4% OASDI component
• State income tax considerations favor the deduction approach
• Retirement plan contributions can be maximized based on higher compensation

Strategy 2: Strategic Acquisition of Qualified Property

For capital-intensive businesses or those with low W-2 wages, the second prong of the limitation formula—25% of W-2 wages plus 2.5% of UBIA of qualified property—may provide a larger QBI deduction. This is particularly relevant for:

• Manufacturing operations with significant equipment investments
• Real estate operating businesses
• Professional service firms that own their office buildings
• Businesses with substantial furniture, fixtures, and equipment

Asset Acquisition Planning Considerations

Timing of Purchases: Since UBIA is based on the original cost at placement in service, acquiring assets before year-end can provide immediate QBI benefits. However, the asset must be placed in service (not merely purchased) to be included.

Cost Segregation Considerations: While cost segregation accelerates depreciation deductions, it does not affect UBIA for QBI purposes. The unadjusted basis remains the original cost regardless of how the asset is classified for depreciation.

Section 179 and Bonus Depreciation: Taking Section 179 expense or bonus depreciation does not reduce the UBIA for QBI purposes. The original cost continues to be used for the full depreciable period (minimum ten years).

Real Property Considerations: Buildings have a depreciable period of 27.5 years (residential) or 39 years (nonresidential), meaning they remain qualified property for their entire depreciable life. Purchasing real property used in the business can provide substantial, long-term UBIA benefits.

Illustrative Example: The UBIA Advantage

Consider a manufacturing S corporation with the following characteristics:

• QBI: $800,000
• W-2 wages: $150,000
• UBIA of qualified property: $2,000,000 (machinery, equipment, building)
• Owner’s taxable income: Above the phase-in range

Calculation:

• Potential QBI deduction (20% × $800,000): $160,000
• Limitation Option 1 (50% of W-2 wages): $75,000
• Limitation Option 2 (25% of wages + 2.5% of UBIA): $37,500 + $50,000 = $87,500
• Allowed QBI deduction: $87,500 (the greater of the two options)

In this case, the substantial investment in depreciable property provides an additional $12,500 in QBI deduction compared to relying solely on W-2 wages.

Strategy 3: Hiring Employees vs. Using Contractors

For businesses that rely heavily on independent contractors, converting appropriate contractor relationships to employee relationships can increase W-2 wages and expand the QBI deduction. This decision requires careful analysis of:

• Whether the worker relationship properly qualifies for employee classification under IRS guidelines
• The additional costs of employment (benefits, unemployment taxes, workers’ compensation)
• The QBI deduction benefit gained from the additional W-2 wages
• State law implications for worker classification

Strategy 4: Entity Structure and Business Aggregation

Taxpayers who own multiple businesses may benefit from aggregating them for QBI purposes. Aggregation allows combining the W-2 wages and UBIA from multiple businesses when calculating the limitation. This can be particularly beneficial when:

• One business has high QBI but low wages/property
• Another business has low QBI but high wages/property
• The combined limitation provides greater total deduction

However, businesses can only be aggregated if they share common ownership (50% or greater) and meet additional tests regarding shared facilities, suppliers, or services. Importantly, specified service trades or businesses cannot be aggregated with non-SSTB businesses.

Conclusion and Planning Implications

The permanent extension of the QBI deduction under the OBBBA provides pass-through business owners with long-term planning certainty that was previously unavailable. With the 20% deduction now a permanent feature of the tax code, S corporation owners and their advisors can confidently implement multi-year strategies around compensation levels and asset acquisitions.

Key takeaways for practitioners and business owners include:

• Reconsider the traditional “minimize wages” approach. For higher-income S corporation owners, paying additional W-2 wages may generate greater overall tax savings through increased QBI deductions.
• Evaluate asset acquisition timing. Strategic purchases of depreciable property can significantly increase the QBI deduction through the UBIA component, particularly for capital-intensive businesses.
• Model both limitation formulas. Always calculate both the 50% W-2 wage limitation and the 25% W-2 plus 2.5% UBIA alternative to determine which provides the greater deduction.
• Consider business aggregation. For owners of multiple related businesses, aggregation may provide more favorable combined limitations.
• SSTB owners should focus on income management. Strategic use of retirement plans, charitable contributions, and income timing can preserve at least partial QBI deductions within the phase-in range.
• Leverage expanded OBBBA thresholds. The increased phase-in ranges under OBBBA provide additional planning flexibility for taxpayers near the threshold amounts.

As with all tax planning, the interplay between QBI strategies and other tax provisions requires comprehensive modeling. Decisions regarding compensation levels affect payroll taxes, retirement plan contributions, and Medicare surtaxes. Asset purchases impact depreciation deductions, Section 179 elections, and cash flow. A holistic approach that considers all relevant factors will yield the optimal outcome for each taxpayer’s unique circumstances.

The QBI deduction represents one of the most significant tax benefits available to pass-through entity owners. With proper planning, S corporation shareholders can navigate the income-based limitations and maximize the value of this permanent tax provision.

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Disclaimer: This article is provided for educational and informational purposes only and does not constitute tax, legal, or financial advice. Tax laws are complex and subject to change. Readers should consult with their own qualified tax advisors regarding their specific circumstances before implementing any tax planning strategies discussed herein.