Learn what qualified business income is, how the Section 199A deduction works, who may qualify, which limits apply, and how California differs.
The Qualified Business Income Deduction—also called the QBI deduction or Section 199A deduction—is a federal deduction for eligible taxpayers with QBI from a domestic trade or business. It can be up to 20% of qualified business income, but taxable-income, wage, property, business-type, and loss limits can reduce it. It applies to income from pass-through entities including sole proprietorships, partnerships, and S corporations.
QBI is generally the net qualified income, gain, deduction, and loss from an eligible domestic trade or business. It can arise from:
A C corporation does not generate QBI for its shareholders. Employee wages are not QBI. S corporation reasonable compensation and partnership guaranteed payments for services are generally excluded. Capital gains and losses, most dividends, unrelated interest, and foreign business income are generally excluded.
QBI is not always identical to Schedule C profit or a Schedule K-1 amount. The deductible portion of self-employment tax, self-employed health insurance, retirement contributions, QBI losses, and business allocations may change it.
The tentative QBI component begins with 20% of net QBI. It is generally limited to 20% of taxable income before the deduction, reduced by net capital gain. Qualified REIT dividends and publicly traded partnership income can create another component.
When taxable income exceeds the annual threshold, the calculation can become more complex. W-2 wages paid by the business, the unadjusted basis immediately after acquisition of qualified property, and whether the activity is a specified service trade or business may limit the deduction.
Specified service trades or businesses can include health, law, accounting, consulting, financial services, brokerage services, athletics, and performing arts. Architecture and engineering are specifically excluded. Classification depends on the actual activity, not merely the business name.
Assume a sole proprietor has $100,000 of Schedule C net profit. After $7,000 of deductions properly allocable to the business for QBI purposes, QBI is $93,000. Assume taxable income before the QBI deduction is $80,000, with no net capital gain.
| Calculation step | Amount |
|---|---|
| 20% of QBI ($93,000 × 20%) | $18,600 |
| Taxable-income limit ($80,000 × 20%) | $16,000 |
| Preliminary deduction (lesser amount) | $16,000 |
The deduction does not reduce Schedule C profit or self-employment tax. It reduces federal taxable income.
Federal legislation enacted in 2025 made Section 199A permanent instead of allowing it to expire after 2025. For 2026, the taxable-income threshold is $403,500 for married couples filing jointly, $201,775 for married individuals filing separately, and $201,750 for other returns.
Beginning in 2026, eligible taxpayers who materially participate in the active businesses generating QBI can receive a minimum $400 deduction when aggregate QBI from those businesses is at least $1,000, subject to the detailed statutory rules. Thresholds are not a simple cliff—wage/property and SSTB limitations phase in across the applicable range.
Individuals generally calculate the deduction on Form 8995 or Form 8995-A. Partnerships and S corporations do not claim the owner-level deduction. Instead, they provide Section 199A information to partners and shareholders on Schedule K-1 or an attachment.
The deduction is reported on Form 1040 after the standard or itemized deduction. It does not reduce adjusted gross income, self-employment tax, or business book profit. Form 8995 is the simplified form for taxpayers who meet its conditions. Form 8995-A handles wage/property limitations, SSTBs, aggregations, and other complex calculations.
Qualified-business losses are netted under Section 199A. A negative combined QBI amount can carry forward and reduce later QBI. This is separate from an income-tax net operating loss carryforward. Taxpayers may aggregate qualifying businesses when regulatory requirements are met, which can affect wages and property used in the limitation.
California does not conform to the federal Section 199A deduction for personal income tax purposes. A California business owner may receive a federal QBI deduction while receiving no corresponding California deduction. Do not subtract the federal QBI deduction on the California return.
The underlying business income generally remains part of California income. California's pass-through entity elective tax is a separate state regime and should not be described as California's version of the QBI deduction.
Heath Income Tax can reconcile QBI statements, calculate the federal deduction, track QBI losses, review entity and compensation effects, and correctly separate federal and California treatment.
Is QBI the same as business profit?
Not always. Business profit is a starting point, but QBI-specific additions, reductions, exclusions, and loss rules apply.
Can I claim the QBI deduction if I take the standard deduction?
Yes. It is available to eligible taxpayers whether they take the standard deduction or itemize.
Does an S corporation qualify?
The corporation passes Section 199A information to shareholders. An eligible shareholder calculates the deduction; reasonable compensation is not QBI.
Does rental income qualify?
It may if the rental activity is a Section 162 trade or business or meets an applicable safe harbor. Merely owning rental property does not guarantee qualification.
Does the deduction reduce self-employment tax?
No. It generally reduces federal taxable income, not net earnings from self-employment.
The definitions and examples on this page are for informational purposes only and do not constitute tax advice. Tax laws change frequently and individual circumstances vary. Consult a qualified tax professional before making decisions based on this content.
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