How To Maximize Tax Savings with the QBI Deduction for Small Business Owners
Running a small business means working hard to earn money, but keeping more of it is just as important. Taxes can take a big chunk of your income, but the Qualified Business Income (QBI) deduction can help. It lets you deduct up to 20% of your business income to reduce what you owe.
If you’re not sure how to take advantage of the QBI deduction or whether you even qualify, don’t worry. This guide will walk you through who qualifies, how it works, and strategies to maximize your savings as a small business owner.
What Is the Qualified Business Income Deduction?
The QBI deduction, also known as the Sec. 199A deduction was introduced in 2018 under the Tax Cuts and Jobs Act (TCJA) as a tax break for small business owners. It allows sole proprietors, partnerships, S corporations, and some trusts and estates to deduct up to 20% of their qualified business income (QBI) on their personal tax return.
However, C corporations don’t qualify, and there are restrictions on high-income business owners, especially those in service-based industries.
What Counts as Qualified Business Income?
QBI is the net profit your business earns from regular operations, minus business deductions like self-employment tax, health insurance, and retirement contributions. But not all income qualifies. Here’s what doesn’t count:
- Wages earned as an employee
- Capital gains and losses
- Dividends and interest income
- Income from businesses outside the U.S.
- Guaranteed payments to partners
Since foreign earnings don’t count, businesses operating internationally will only be able to deduct income earned within the United States.
Who Qualifies for the QBI Deduction?
Your eligibility depends on your total taxable income, your business type, and whether you fall under a Specified Service Trade or Business (SSTB).
Specified Service Trades or Businesses (SSTBs)
If your business is in an industry where success is mainly tied to your skill or reputation, you may face additional restrictions. The IRS classifies the following professions as SSTBs:
- Law
- Medicine
- Consulting
- Accounting
- Financial services
- Performing arts
- Athletics
- Investment management
If your taxable income exceeds the phase-out limits, the deduction completely disappears for SSTBs. However, if you stay below the income threshold, you may still qualify.
Note that businesses like architecture and engineering firms aren’t considered SSTBs, so they qualify regardless of income.
How To Calculate the QBI Deduction
If you qualify, the QBI deduction allows you to deduct 20% of your qualified business income.
For example, if your business earns $100,000, you could deduct $20,000, leaving $80,000 taxable instead of $100,000.
However, the deduction can’t exceed 20% of your taxable income (excluding capital gains).
If your income is above the phase-out threshold, your deduction is limited based on:
- W-2 wages paid to employees
- Qualified property ownership (such as machinery or real estate)
The deduction is then capped at the lesser of:
- 20% of your QBI, or
- The greater of:
- 50% of W-2 wages paid by the business, OR
- 25% of W-2 wages plus 2.5% of the cost of depreciable property owned by the business
If your business doesn’t pay W-2 wages or own depreciable property, your deduction could shrink significantly if you exceed the income limit.
Strategies to Maximize the QBI Deduction
Here are some strategies to ensure you get the most out of this deduction:
1. Keep Your Taxable Income Below the Threshold
Since the QBI deduction phases out at higher income levels, staying under the limit is crucial. You can do this by:
- Deferring income (waiting to invoice clients until next year)
- Accelerating deductions (prepaying rent, supplies, or services)
- Making retirement contributions (such as SEP IRAs or Solo 401(k)s)
For instance, if you’re a married business owner earning $400,000, you could contribute to a SEP-IRA to lower your taxable income below the phase-out threshold. This could restore their QBI deduction and reduce your tax bill significantly.
2. Pay Yourself W-2 Wages (For S Corporations)
If you own an S corporation, paying yourself a reasonable salary as a W-2 employee can help maximize your deduction.
Since higher-income businesses are limited by W-2 wages, increasing wages (within reason) can increase your deduction.
3. Invest in Qualified Business Property
If you don’t have W-2 employees, buying business assets like machinery, vehicles, or office space can help maximize the 2.5% property calculation in the deduction formula.
4. Separate SSTB and Non-SSTB Activities
If you run an SSTB and another non-SSTB business, consider separating them into different entities. This could allow the non-SSTB business to still qualify for the deduction, even if the SSTB portion phases out.
For example, if you own a medical practice (SSTB) and a medical equipment company, structuring them as separate businesses might help preserve the deduction for the equipment side.
5. File Separately (For Married Couples)
If one spouse owns an SSTB and their combined income exceeds the phase-out range, filing separately could keep the SSTB-earning spouse below the income cap—allowing them to still qualify.
Common Mistakes to Avoid
While the QBI deduction offers substantial tax savings, some business owners make costly mistakes that reduce their benefits. Here are common errors to watch out for:
- Failing to plan for the income threshold – If you don’t manage your taxable income strategically, you could unintentionally phase out of the deduction.
- Not paying W-2 wages when needed – If your business has no employees, you might lose part of the deduction due to the wage limitation.
- Assuming all business income qualifies – QBI does not include capital gains, dividends, or rental income (unless rental real estate qualifies as a trade or business).
- Overlooking retirement contributions – While retirement contributions reduce taxable income, they also lower QBI, so balance is key.
The QBI Deduction Will Sunset After 2025
The Sec. 199A deduction is set to expire after December 31, 2025, unless Congress extends it. Business owners should take advantage of this deduction while it lasts and consider long-term tax planning strategies to prepare for any potential changes in tax law.
