The Small Business Guide to Qualifying for the 20% QBI Deduction in 2025

The smartest small business owners aren’t just working in their business: they’re saving tens of thousands of dollars by taking advantage of the Qualified Business Income (QBI) deduction, one of the most significant tax breaks available today. 

As you juggle everything from payroll to customer service, you’re likely leaving money on the table if you haven’t structured your business to maximize this powerful 20% tax break. With this deduction scheduled to change after 2025, the clock is ticking to understand how your current business setup could cost (or save) you thousands when tax season arrives.

What Is QBI Deduction: Understanding the Basics

The QBI deduction, established under the Tax Cuts and Jobs Act, provides substantial tax savings for pass-through business entities.

This tax provision allows owners of sole proprietorships, partnerships, S corporations, and some trusts and estates to deduct up to 20% of their qualified business income on their personal tax returns.

This deduction is set to expire after 2025 unless Congress acts to extend it, making it essential for business owners to maximize their benefits while they still can. Understanding how different business structures affect your eligibility is the first step toward optimizing your tax situation.

What Is Section 199A and Why It Matters

Section 199A of the Internal Revenue Code is the specific provision that created the QBI deduction. This tax code section outlines who qualifies for the deduction, how it’s calculated, and what limitations apply.

Under Section 199A, businesses in any industry can qualify. Still, thresholds and limitations exist, particularly for specified service trades or businesses (SSTBs) such as healthcare providers, attorneys, accountants, financial advisors, and consultants.

Is Taxable Business Income Before Deductions?

A common question is whether QBI is calculated on gross or net income. Is taxable business income before deductions included in QBI? Here’s what you need to know:

• QBI is based on net business income – It’s calculated after most business deductions have been taken, not on gross revenue
• Business expenses reduce your QBI – Your ordinary business expenses, including employee wages, are subtracted before determining your QBI amount
• QBI represents your business profit – Technically, it’s the net amount of qualified items of income, gain, deduction, and loss from your qualified trade or business
• The QBI deduction itself happens later – Unlike business expenses, the QBI deduction is applied on your personal tax return after your business income is calculated
• This creates a double benefit – Your business deductions reduce taxable income once, then the QBI deduction reduces it again by up to 20% of your remaining profit

How Different Business Structures Affect Your QBI Eligibility

Your business structure significantly impacts how you can maximize the QBI deduction before potential 2025 changes. Let’s explore the primary business entities and their implications:

Sole Proprietorship

As a sole proprietor, you report business income on Schedule C of your personal tax return. While this structure offers simplicity, it may limit your ability to maximize the QBI deduction since you cannot pay yourself W-2 wages, which can be crucial for qualifying if your income exceeds certain thresholds.

Partnerships

Partnerships are pass-through entities where business income flows to the partners’ personal tax returns. Partners receive a Schedule K-1 showing their share of the business’s income. Like sole proprietorships, traditional partnerships face limitations since guaranteed payments to partners don’t count as W-2 wages for QBI purposes.

S-Corporations

S corporations offer significant advantages for maximizing the QBI deduction. As an S corporation owner, you can pay yourself a reasonable salary as W-2 wages, and the remaining business profit passes through as QBI. This structure can help optimize your deduction since W-2 wages can help you qualify for the full deduction even at higher income levels.

What is Section 199A‘s wage limitation? For higher-income taxpayers, the QBI deduction is limited to 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 makes S corporations one of the best structures for maximizing the deduction.

LLCs with Different Tax Elections

Limited Liability Companies (LLCs) are flexible entities that can elect to be taxed as sole proprietorships, partnerships, S corporations, or even C corporations. Choosing the right tax classification for your LLC can significantly impact your QBI deduction eligibility.

For many small business owners, electing S corporation taxation for their LLC provides the best of both worlds: liability protection and favorable QBI treatment.

Strategies to Maximize Your QBI Deduction Before 2025

With the QBI deduction set to expire after 2025, consider these strategies to maximize your benefits:

1. Reevaluate Your Business Structure

If you currently operate as a sole proprietorship or partnership and your income exceeds the threshold, consider converting to an S corporation. The ability to pay yourself W-2 wages can help you qualify for the full 20% deduction even at higher income levels.

2. Manage Your Taxable Income

Since QBI deduction eligibility changes at certain income thresholds, managing your overall taxable income can help maximize your benefits. Consider strategies like:

• Maximizing retirement contributions
• Timing income and deductions strategically
• Using health savings accounts (HSAs)
• Making charitable contributions

3. Increase Qualified Business Property

For businesses with substantial income but limited W-2 wages, investing in qualified business property can help increase your deduction. The 2.5% unadjusted basis calculation can be valuable for real estate businesses or any entity with significant capital investments.

4. Review Service Business Classification

If you’re in a specified service trade or business (SSTB), the QBI deduction phases out at higher income levels. Consider whether your business activities can be legitimately restructured or separated to maximize non-SSTB income.

5. Consult with Tax Professionals

What is QBI deduction planning worth to your business? Potentially tens of thousands of dollars in tax savings. Working with experienced tax professionals can help you navigate the complexities of Section 199A and implement appropriate strategies for your specific situation.

Plan Now for Potential 2025 Changes

The QBI deduction’s scheduled expiration in 2025 creates urgency for business planning. While Congress may extend this provision, prudent business owners should prepare for multiple scenarios.

By understanding Section 199A and how it applies to your specific business structure, you can make informed decisions to maximize your tax benefits now while positioning your business for success regardless of future tax law changes.

Ready to maximize your QBI deduction? Visit our website or call us at 1-800-508-1729 to speak with our business formation experts who can help you evaluate your current structure and implement strategies to optimize your tax position while protecting your assets.

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.