For owners of sole proprietorships, partnerships, LLCs, and S corporations, the qualified business income deduction can be one of the more meaningful items on a personal tax return. Often called the QBI deduction or the Section 199A deduction, it allows eligible owners to deduct a portion of their qualified business income. It also comes with a set of limitations that make it more complicated than it first appears, and it is subject to ongoing legislative attention. If you want to understand how it may apply to you, a complimentary, no-obligation wealth and tax review can help.
This guide explains, in general terms, how the deduction works, what types of income qualify, how limits come into play, and how the deduction interacts with other planning decisions.
What the QBI Deduction Is
The qualified business income deduction was created to give owners of pass-through businesses a deduction that is calculated as a percentage of their qualified business income, subject to limits. It is taken on the owner's personal return, not on the business return. The deduction does not reduce adjusted gross income; it reduces taxable income, which matters for how it interacts with other parts of the return.
Because Congress has adjusted this area of the tax code over time, the specific percentage, income thresholds, and phase-in ranges are set by current law and adjusted periodically. Rather than relying on a figure from a past year, it helps to confirm the current rules with your tax professional each year.
What Counts as Qualified Business Income
Qualified business income is generally the net income from a qualified trade or business conducted in the United States. It typically excludes:
Investment income such as capital gains, dividends, and most interest
Reasonable compensation paid to an S corporation owner
Guaranteed payments to partners for services
Certain income earned outside the United States
That second item creates a planning tension for S corporation owners. Salary paid to an owner does not count as qualified business income, but the remaining profit can. Setting a reasonable salary is a requirement, not a choice, and it should be supported by the work performed and market data. Our guide on how to pay yourself as a business owner explains the factors involved.
Income Limits and Specified Service Businesses
At lower levels of taxable income, the calculation is relatively simple. As taxable income rises above certain thresholds, additional limits phase in. Two are especially important:
Wage and property limits. Above the threshold, the deduction may be limited based on W-2 wages paid by the business and the cost basis of certain business property.
Specified service trades or businesses. Fields such as health, law, accounting, consulting, financial services, and certain others are treated differently. Above the threshold, owners of these businesses may see the deduction reduced or eliminated.
This means two owners with similar profits can end up with very different deductions depending on their industry, payroll, and total household income. Physicians, attorneys, and consultants in particular often find that their deduction depends heavily on where their taxable income falls.
How the Deduction Interacts With Other Decisions
The QBI deduction rarely stands alone. Several common planning moves can affect it:
Retirement plan contributions. Contributions that reduce taxable income may also reduce qualified business income, which can change the deduction in either direction.
Entity choice. Operating as an S corporation, partnership, or sole proprietorship affects how income is categorized and what counts as wages.
Rental real estate. Some rental activities may qualify under specific rules and safe harbors, while others do not.
Multiple businesses. Owners with several businesses may be able to aggregate them in some situations, which can affect the wage and property limits.
Losses. A loss from one qualified business can reduce the deduction from another, and losses can carry forward for QBI purposes.
Because these pieces interact, it is worth running projections before year end. Our article on tax planning for business owners outlines a multi-year approach.
Wisconsin Considerations
The QBI deduction is a federal deduction. Wisconsin generally does not follow it in the same way, so a deduction that lowers your federal taxable income may not have the same effect on your Wisconsin return. Wisconsin has its own credits and rules for business income, including a credit for certain manufacturing and agricultural income. Coordinating federal and state planning helps you see the full picture rather than optimizing one return at the expense of the other.
Common Questions Owners Ask During Planning
In planning conversations, owners often ask whether to raise or lower their salary, whether to make a larger retirement contribution, or whether to restructure their entity. Each question involves trade-offs among income tax, payroll tax, retirement savings, and the QBI deduction. There is rarely a single right answer, and what fits one year may not fit the next. Integrated tax planning and preparation can help owners model several scenarios before deciding.
Recordkeeping That Supports the Deduction
Because the deduction depends on how income is categorized, good records matter. Owners commonly keep payroll records that support W-2 wages, fixed asset schedules that support the property side of the calculation, and clear books that separate each business when they own more than one. S corporation owners often keep a short memo explaining how they set reasonable compensation, along with the market data they relied on. Partners benefit from reviewing their K-1 each year to confirm that qualified business income, wages, and property figures are reported, since the deduction is calculated on the personal return using information the entity provides.
It also helps to keep track of any qualified business losses carried forward, because those can reduce the deduction in later years even after the business returns to profit. Clean year-end books make these figures easier to produce, which is one reason many owners pair tax planning with ongoing client accounting services.
Next Steps
If you own a business in Madison, Waunakee, or elsewhere in Wisconsin, the qualified business income deduction is likely part of your tax picture. Understanding how it works, and how your other decisions affect it, can help you have more productive conversations with your tax professional.
To talk through your situation, request a complimentary, no-obligation wealth and tax review.
Frequently Asked Questions
Who may qualify for the qualified business income deduction?
Owners of pass-through businesses, including sole proprietors, partners, LLC members, and S corporation shareholders, may qualify, subject to income limits and other rules.
Does my S corporation salary count as qualified business income?
No. Reasonable compensation paid to an S corporation owner is generally excluded from qualified business income, while remaining profit may qualify.
Are doctors and lawyers eligible for the QBI deduction?
They may be, but specified service businesses face additional limits as taxable income rises. Above certain levels, the deduction may be reduced or eliminated.
Does Wisconsin allow the QBI deduction?
Wisconsin generally does not follow the federal QBI deduction in the same way. Confirm current state treatment with a tax professional.
Can retirement contributions affect my QBI deduction?
Yes. Contributions that reduce business income or taxable income can change the deduction, so it helps to model both together.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
Information may be generalized or subject to change. Please contact our team for the most current and accurate information.
About Compound Wealth
Long-term financial planning often involves balancing tax considerations, investment decisions, business interests, and personal financial goals. Compound Wealth provides an integrated planning approach that brings these disciplines together to provide a coordinated framework for evaluating financial decisions as financial circumstances evolve over time.
