By: John S. Morlu II, CPA
The Qualified Business Income (QBI) deduction, introduced by the Tax Cuts and Jobs Act (TCJA), provides a tax-saving opportunity for many small business owners. It allows eligible taxpayers to deduct up to 20% of their QBI, reducing their taxable income. However, the deduction comes with complex rules, limitations, and calculations that depend on income, wages, and capital investments.
This guide will explore the mechanics of the QBI deduction, step-by-step calculation methods, and detailed examples with tables for clarity.
What is QBI?
Qualified Business Income (QBI) is defined as the net income, gains, deductions, and losses from a qualified trade or business conducted within the United States. It specifically excludes certain types of income and deductions, including:
| Included in QBI | Excluded from QBI |
| Net income from a qualified trade or business | Short-term and long-term capital gains or losses |
| Deductions for ordinary and necessary business expenses | Dividends and investment income |
| Depreciation (e.g., Section 179 deductions) | Compensation, guaranteed payments, or payments to partners |
| Certain pass-through income | Annuities, interest income, foreign currency gains |
Carryover of Losses
If QBI results in a net loss, that loss is carried forward to offset QBI in the following tax year, reducing the deduction in subsequent years.
Who Qualifies for the QBI Deduction?
The QBI deduction is available to:
- Individuals
- Trusts and estates
The deduction is calculated at the individual taxpayer level, meaning multiple business owners may qualify differently based on their personal tax situation.
How to Calculate the QBI Deduction
The QBI deduction is the lesser of:
- 20% of QBI for the tax year, or
- The taxable income limitation, calculated as 20% of the taxpayer’s taxable income minus net capital gains.
For taxpayers with taxable income above certain thresholds, the deduction is further limited based on:
- W-2 wages paid by the business
- The unadjusted basis immediately after acquisition (UBIA) of qualified property
Step-by-Step Calculation
1. Identify QBI
QBI includes net income from qualified businesses, reduced by expenses, depreciation, and other allowable deductions. Losses are carried forward.
2. Determine Taxable Income
Taxable income is calculated before applying the QBI deduction but includes all other deductions, such as the standard deduction or itemized deductions.
3. Apply Thresholds
For 2024, the income thresholds are:
| Filing Status | Threshold Amount | Upper Phase-Out Limit |
| Married Filing Jointly | $383,900 | $483,900 |
| All Other Filing Statuses | $191,950 | $241,950 |
Taxpayers below the threshold can claim the full 20% deduction. Taxpayers above the threshold are subject to limitations based on wages and capital.
4. Apply Wage and Capital Limits
For taxpayers exceeding the threshold, the QBI deduction is limited to the lesser of:
- 20% of QBI, or
- The greater of:
- 50% of W-2 wages paid by the business, or
- 25% of W-2 wages plus 2.5% of UBIA of qualified property.
5. Phase-In/Phase-Out Adjustments
If taxable income is within the phase-out range, a phase-in calculation applies to gradually reduce the deduction.
Examples with Detailed Tables
Example 1: Income Below the Threshold
Taxpayer Profile:
- Filing Status: Married Filing Jointly
- Taxable Income: $300,000
- QBI: $150,000
- W-2 Wages: $40,000
- UBIA: $200,000
| Step | Calculation | Result |
| 1. Calculate 20% of QBI | $150,000 × 20% | $30,000 |
| 2. Calculate Wage and Capital Limits: | ||
| – 50% of W-2 Wages | $40,000 × 50% | $20,000 |
| – 25% of W-2 Wages + 2.5% of UBIA | ($40,000 × 25%) + ($200,000 × 2.5%) | $10,000 + $5,000 = $15,000 |
| 3. Apply Wage and Capital Test | Greater of $20,000 or $15,000 | $20,000 |
| 4. Lesser of QBI Deduction or Limits | Lesser of $30,000 or $20,000 | $20,000 |
• QBI Deduction: $20,000
Example 2: Income Above Threshold but Within Phase-Out Range
Taxpayer Profile:
- Filing Status: Married Filing Jointly
- Taxable Income: $450,000
- QBI: $150,000
- W-2 Wages: $40,000
- UBIA: $200,000
| Step | Calculation | Result |
| 1. Calculate 20% of QBI | $150,000 × 20% | $30,000 |
| 2. Calculate Wage and Capital Limits: | ||
| – 50% of W-2 Wages | $40,000 × 50% | $20,000 |
| – 25% of W-2 Wages + 2.5% of UBIA | ($40,000 × 25%) + ($200,000 × 2.5%) | $10,000 + $5,000 = $15,000 |
| 3. Apply Wage and Capital Test | Greater of $20,000 or $15,000 | $20,000 |
| 4. Determine Phase-Out Percentage | ($450,000 – $383,900) ÷ $100,000 | 66.10% |
| 5. Calculate Reduction | $30,000 – ($30,000 – $20,000) × 66.1% | $23,390 |
• QBI Deduction: $23,390
Example 3: Income Exceeds Upper Limit
Taxpayer Profile:
- Filing Status: Married Filing Jointly
- Taxable Income: $500,000
- QBI: $150,000
- W-2 Wages: $40,000
- UBIA: $200,000
| Step | Calculation | Result |
| 1. Calculate 20% of QBI | $150,000 × 20% | $30,000 |
| 2. Calculate Wage and Capital Limits: | ||
| – 50% of W-2 Wages | $40,000 × 50% | $20,000 |
| – 25% of W-2 Wages + 2.5% of UBIA | ($40,000 × 25%) + ($200,000 × 2.5%) | $10,000 + $5,000 = $15,000 |
| 3. Apply Wage and Capital Test | Greater of $20,000 or $15,000 | $20,000 |
| 4. No Deduction Above Upper Limit | $0 |
• QBI Deduction: $0
Key Considerations
1. Wages and Capital Investments Matter:
Businesses with no employees or minimal assets may not qualify for the deduction at higher income levels.
2. Phase-Out Complexity:
Taxpayers within the phase-out range face reduced deductions, requiring precise calculations.
3. Tax Planning Strategies:
- Increase W-2 wages by paying owner-employees reasonable salaries.
- Invest in qualified property to raise UBIA.
- Consider entity restructuring if the QBI deduction offers significant savings.
Conclusion
The QBI deduction is a valuable tax tool, but its complexity requires careful attention to income thresholds, wage limitations, and capital investments. Understanding these details ensures taxpayers can maximize their deduction and minimize tax liabilities. For businesses with high income or unique structures, consulting a tax professional is essential to fully utilize this benefit.
Author: John S. Morlu II, CPA
John S. Morlu II, CPA, is the CEO and Chief Strategist of JS Morlu, a licensed public accounting and management consulting firm. He has more than 20 years of professional experience in auditing and advisory work, including service as Auditor General of Liberia and FAR and DCAA compliance work at Unisys Federal Systems.
The firm’s technology products include:
• ReckSoft (www.ReckSoft.com): AI-driven reconciliation software for financial accuracy and efficiency.
• FinovatePro (www.FinovatePro.com): Advanced cloud accounting solutions for growing businesses.
• Fixaars (www.fixaars.com): A global handyman platform for home and property services.