QBI Deduction: Guide for Small Business Owners

As a small business owner, you likely don’t look forward to tax season. While friends with traditional jobs might get refunds or small bills, you might be staring at a tax obligation that feels insurmountable. Every dollar you owe is a dollar you can’t spend to hire help, buy ads, or simply breathe a little easier.

Here’s where the qualified business income (QBI) deduction comes in. This provision of the US Tax Cuts and Jobs Act (TCJA) allows eligible small business owners to deduct up to 20% of their income directly from their personal tax return. Whether you’re a freelancer, consultant, or brick-and-mortar business owner, understanding the QBI deduction could mean the difference between dreading April 15 and possibly looking forward to it. Or, at the very least, not losing sleep over it.

What is the business income QBI deduction?

The qualified business income (QBI) deduction is a federal tax deduction that allows eligible self-employed individuals and business owners to deduct up to 20% of their business income on their personal income tax returns. Known as a pass-through deduction, the QBI deduction applies to income earned from pass-through entities: sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs). These are entities that report income on the owner’s personal tax return rather than paying federal corporate income tax.

The US Internal Revenue Service (IRS) designed this tax deduction to provide relief for owners of pass-through businesses. The TCJA cut the federal corporate tax rate from 35% to 21%, and the QBI deduction provides a similar cut to pass-through businesses by allowing them to deduct 20% of their income. For example, a pass-through business owner in the 24% tax bracket who claims the full QBI deduction pays a cut rate of about 19.2% on their business income (24% x 80% = 19.2%). This helps level the tax-burden playing field between traditional C corps and pass-through entities like LLCs and sole proprietorships. The deduction is available for tax years beginning after December 31, 2017.

It’s important to note, however, that the current QBI program is set to expire after the 2025 tax year—unless Congress acts to extend it. Both the House and Senate versions of the One Big Beautiful Bill Act (BBB) include extensions for the QBI deduction.

How does the QBI deduction work?

The QBI deduction functions as a below-the-line deduction, meaning it reduces taxable income after calculating adjusted gross income (AGI). Unlike above-the-line deductions like the home office deduction or the deduction for self-employed health insurance premiums, the QBI deduction “stacks” in your tax calculation. This means it applies after you subtract above-the-line deductions from your gross income, and after subsequent application of either the standard deduction or itemized tax deductions (whichever is higher). Many people think you have to choose between deductions—but the QBI is additive. You don’t have to give up your standard deduction to get QBI benefits. It’s essentially a discount on top of a discount.

To illustrate this “stacking” mechanism, here’s an example. Let’s say for 2026 you have a gross income of $100,000, and $5,000 in above-the-line deductions (like IRA contributions). This brings your AGI to $95,000. Then you take the standard 2025 deduction of $15,000 for a single filer, leaving you with an income before QBI of $80,000. Here is where you take the QBI deduction—below the line. Let’s say you qualify for the full 20% QBI, which would entitle you to a further $16,000 deduction, leaving you with a final qualified business income of $64,000.

Factors that determine QBI deduction eligibility

• Income limits
• Pass-through income and qualifying businesses
• Specified service trades or businesses

Eligibility for the QBI deduction hinges on two factors: your income level and the type of business you own. 

Income limits

The IRS imposes thresholds on total taxable income to determine whether you can claim the full QBI deduction or a reduced amount. These thresholds apply to your household’s total taxable income—not just your qualified business income. While the QBI deduction is a percentage of your QBI, the IRS looks at how much money you actually bring in annually to determine QBI deduction eligibility (including a spouse’s income, non-qualifying investment income, and more).

For 2025, those thresholds are:

• Below $197,300 (single filer)/$394,600 (married filing jointly): You can receive the full 20% QBI deduction.

• From $197,301–$247,300 (single filer)/$394,601–$494,600 (married filing jointly): You enter the so-called “phase-in range” where your deduction is gradually deduced based on how much you pay in employee wages and how much you’ve invested in qualifying business property.

• Above $247,300 (single filer)/$494,600 (married filing jointly): Your QBI deduction is limited to the higher of either half of what you pay employees in wages, or 25% of employee wages plus a small percentage of your qualifying business equipment or property investments. If you have no employees or qualifying equipment or property investments, you would be ineligible for the deduction.

Some examples of qualifying business equipment and property that count toward the QBI limitation calculation include computers, equipment and tools, kitchen appliances, office furniture and fixtures, and company vehicles. For QBI purposes, the calculation uses the equipment/property’s unadjusted basis immediately after acquisition (UBIA), which is basically the purchase price.

If you have no employees or qualifying equipment/property investments, you lose the QBI deduction once your income exceeds the upper threshold. The good news is that you can obtain this deduction by either hiring employees or investing in your business ahead of time.

Pass-through income and qualifying businesses

The QBI deduction applies to income from qualified trade or business activities conducted through pass-through entities. These include:

• Sole proprietorships reporting on Schedule C

• Single-member LLCs treated as sole proprietorships for tax purposes

• Multi-member LLCs taxed as partnerships

• S corps and LLCs taxed as S corps

• Partnerships

If your business is one of the above entity types, it must also operate in a qualifying business sector in order to benefit from the QBI deduction. These are:

• Manufacturing and production

• Ecommerce, retail, and wholesale

• Construction and contracting

• Transportation and logistics

• Hospitality and food service

• Technology and software

• Real estate (rental activities that constitute a trade or business)

• Agricultural or horticultural cooperatives

• Vehicle repair and maintenance services

• Marketing and advertising

• Financial services (excluding investment management)

Specified service trades or businesses

Some specified service trade or business (SSTB) sectors can qualify for the QBI deduction, but face limitations on income to which the QBI deduction can be applied. The IRS defines an SSTB as “a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading or dealing in certain assets, or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.”

If your 2025 taxable SSTB income is at or below $197,300 for single filers, or $394,600 for married joint filers, the SSTB designation is essentially irrelevant—your business is treated like any other non-SSTB qualifying business. If your total taxable income is in the phase-in range, you can claim the QBI deduction according to phase-in rules (taking into account employee wages and qualified property held). However, If you earn above the phase-in range, you are not permitted to claim any QBI deduction based on your SSTB income. It does not matter if you hire employees or invest in qualifying business equipment or property. This is the key distinction between an SSTB and a standard qualifying business when it comes to calculating the QBI deduction.

REIT and PTP income

The QBI deduction also covers qualified real estate investment trust (REIT) dividends and income from a qualified publicly traded partnership (PTP). Small business owners who invest their profits in these investment vehicles can qualify for additional QBI deductions beyond their primary business income.

If you have both business QBI and qualifying REIT/PTP income, your total deduction is limited to 20% of your combined qualifying income or 20% of your taxable income minus net capital gains from any source (e.g., REIT/PTP income, but also other investment income, like capital gains distributions from mutual funds), whichever is less.

What counts as qualified business income?

REITs and PTPs provide a glimpse into what kind of income qualifies for the QBI deduction. The key here is distinguishing between active business income and passive investment income. The QBI deduction is meant for those who run a business, not those who sit back and collect passive returns.

Qualifying business income

• Business profits. The money earned by a qualifying business, minus expenses

• Rental income. Revenue from rental properties, but only if you’re actively involved in managing them (not just collecting rent checks)

• REIT dividends and PTP income

Non-qualifying income

• Investment gains. Profits from selling stocks, bonds, and other investments

• Salary and wages. Money you earn as someone else’s employee (i.e., third-party W-2 income)

• Interest and dividends. Returns from bank accounts, certificates of deposit (CDs), or stock dividends (except qualifying REIT dividends)

• Guaranteed payments. Fixed payments to business partners regardless of business performance (usually specified in a partnership agreement)

• Income earned outside the US. The QBI deduction is only available for qualifying domestic business activities. Even if income is otherwise qualifying under QBI rules, if you earned it in another country, you cannot apply the QBI deduction.

How to calculate your QBI

1. Assess business eligibility and income qualification
2. Calculate total taxable income
3. Determine your QBI based on which threshold your income meets
4. Report it on Form 8995

Calculating your QBI deduction involves several steps and considerations that vary depending on business type and total taxable income. The process can be complex. A tax professional can help you navigate each step.

1. Assess business eligibility and income qualification

Determine whether your business qualifies for the QBI deduction based on its entity type and line of business. All pass-through entities, like sole proprietorships and LLCs, qualify. Businesses in SSTB sectors face income-based restrictions that can eliminate the deduction entirely at higher income levels. Also confirm that your income comes from qualified business activities rather than investment income, third-party employment wages, or other excluded sources.

2. Calculate total taxable income

Add up all your income sources and subtract your deductions to determine your total taxable income (as calculated on Form 1040). This includes your business income plus any other income, like spouse’s wages, investment returns, or rental income. Remember: Your total taxable income determines which rules apply to your QBI calculation—not solely the income you generate from the qualifying business.

3. Determine your QBI based on which threshold your income meets

In 2025, if your taxable income is below the $197,300/$394,600 threshold, even if you’re an SSTB, your QBI deduction is simply 20% of your qualifying business income, capped at 20% of your taxable income minus net capital gains and qualified dividends. Above these thresholds, non-service businesses face wage and property limitations, while SSTBs gradually lose the deduction entirely once income exceeds $247,300/$494,600.

4. Report it on Form 8995

Use IRS Form 8995 if your taxable income is below the threshold amounts, or Form 8995-A if you’re in the phase-in range or above.

QBI deduction example

Here’s a hypothetical example of how the QBI deduction could work for the owner of a small direct-to-consumer apparel brand incorporated as a single-member LLC. We’ll call her Jane. Consider Jane, who is a single filer. She has $95,000 in business income from her ecommerce clothing retail business, which is formed as a single-member LLC. She also receives $5,000 a year in passive investment income.

• Step 1: Jane’s ecommerce clothing retail LLC qualifies as a non-SSTB business since retail operations are not considered a specified service trade. Her LLC, which is treated as a sole proprietorship for tax purposes by the IRS—also qualifies for the QBI deduction.

• Step 2: Jane’s total taxable income is $100,000, which includes her business profits after expenses and her non-qualifying investment income.

• Step 3: Since Jane’s total taxable income falls well below the 2025 tax year threshold of $197,300 for single filers, she qualifies for the simplified calculation with no wage or property limitations.

• Step 4: Jane’s QBI deduction is the lesser of either 20% of her qualified business income, or 20% of her taxable income minus net capital gains.

For Jane, the first option comes out to $95,000 x 20%, or $19,000; and the second option comes out to $100,000 x 20%, or $20,000. The lesser of these two is the first option. Therefore, Jane’s QBI deduction is $19,000, and her taxable income after applying the QBI deduction is $95,000 - $19,000, or $76,000. Assuming a 24% tax bracket, applying the QBI deduction saves her approximately $4,560 in federal income taxes.

Given the complexity of these calculations, consulting with a qualified tax professional can be highly beneficial to ensure proper application of QBI rules and maximize your deduction benefit.