Section 199A deduction: What is it and how do you qualify?

While most business owners know about common write-offs and tax breaks like office supplies and insurance, you might be missing a powerful tax benefit. The Section 199A deduction—often called the Qualified Business Income (QBI) deduction—could allow you to deduct up to 20% of your business income from your taxes.

Think of it as the government's way of giving qualified small business owners a significant tax break. If you're running a pass-through business like a sole proprietorship, partnership, or S corporation, you can reduce your tax bill by thousands of dollars.

Let's explore how this deduction works and whether your business qualifies for this valuable tax benefit.

Jump to:

• How does the Section 199A deduction work?
• Section 199A deduction eligibility criteria
• Calculating the Section 199A deduction
• Income limits and phase-outs for Section 199A
• Rental property and Section 199A
• Multiple businesses and Section 199A
• Common pitfalls to avoid with Section 199A deductions
• Find peace of mind come tax time
• Section 199A FAQ

How does the Section 199A deduction work?

Section 199A is a qualified business income (QBI) deduction. Using it, domestic businesses can deduct roughly 20% of their QBI, along with 20% of their publicly traded partnership income (PTP) and real estate investment trust (REIT) income.

The deduction is limited to 20% of taxable income, but this deduction isn’t for everyone. There are income limitations, as well as business limitations. Specified service trades or businesses (SSTBs), such as businesses performing health, law, and accounting services, may still get a partial deduction if their income falls within the ranges.

Section 199A deduction eligibility criteria

If you’re looking into claiming the Section 199A deduction, you have to understand the qualifications and how it works. It’s always good to check with your CPA or a tax professional who can explain this deduction and help you review its impact on your business. 

Here are the facts to help you grasp the Section 199A deduction:

Pass-through business requirement

The Section 199A deduction primarily benefits pass-through entities and sole proprietorships. Unlike traditional corporations, these business structures don't pay tax at the entity level; instead, profits and losses flow through to the owners' tax returns. 

Understanding which business structures qualify is essential for claiming this deduction. The eligible business structures include: 

• Sole proprietorships
• Partnerships
• S corporations
• LLCs (taxed as pass-through entities)
• Real estate investment trusts (REITs)
• Qualified cooperatives

Domestic business requirement

To qualify for the deduction, businesses must operate within the US. This means:

• Business activities must be domestic
• Income must connect with US trade or business
• Foreign income is explicitly excluded

So in addition to the pass-through and domestic business requirements, you’ll also want to ensure all of your income qualifies. 

Income qualification types

The types of income that qualify for Section 199A include income from domestic pass-through businesses. Income that qualifies includes: 

• Net income from qualified trades or businesses
• Schedule C business income
• Rental property income (Schedule E)
• Farm income (Schedule F)
• REIT dividends
• Qualified cooperative dividends
• Partnership and S corporation income

With that in mind, Section 199A deductions exclude some forms of income. Here are the income types disqualified from Section 199A: 

• Capital gains or losses
• Dividend income
• Nonbusiness interest income
• Owner wage income
• Foreign earned income
• Guaranteed payments to partners

For all of these eligibility requirements, regularly review your qualification status and documentation to ensure continued eligibility.

Calculating the Section 199A deduction

The actual Section 199A deduction you'll receive depends on several factors and limitations. However, the basic QBI calculation formula is: 

Qualified business income (QBI) x 20% = Potential deduction 

If your QBI is $100,000, your potential deduction would be 20% of that or $20,000 ($100,000 x 20%). In other words, your deduction cannot exceed 20% of your taxable income minus net capital gains. 

For example, say your total taxable income is $150,000, and you have capital gains of $30,000. Your adjusted taxable income is $120,000, making the maximum possible deduction $24,000 ($120,000 x 20%).

Income limits and phase-outs for Section 199A

To qualify for the Section 199A deduction, you must also meet income requirements. The income thresholds for 2024 are as follows: 

Single filers:

• Full deduction: Taxable income below $191,950
• Phase-out range: Taxable income between $191,951 and $241,950
• Limited deduction: Taxable income above $241,950

Married filing jointly:

• Full deduction: Taxable income below $383,900
• Phase-out range: Taxable income between $383,901 and $483,900
• Limited deduction: Taxable income above $483,900

Note that SSTB rules add another layer of complexity. Below the income thresholds, SSTBs qualify for full deduction benefits. There are W-2 wage limitations for SSTBs. These are for W-2 wages paid to employees, including owner-employees. Here are the limitations: 

• 50% of W-2 Wages: Deduction is limited to 50% of the W-2 wages paid to employees. 
• 25% of W-2 Wages + 2.5% of qualified property: Alternatively, the deduction can be limited to 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property used in the business.

Above the phase-out range, SSTB income becomes completely ineligible for the deduction. 

Rental property and Section 199A

Rental real estate income from tangible property can qualify as business income, subject to the same thresholds established for single and joint filers. However, not all rental activities automatically qualify, and property owners must meet specific criteria to benefit from this deduction.

To qualify rental activities as a trade or business under Section 199A, property owners must demonstrate three key elements:

1. Regular and continuous activity: You must spend regular time on rental activities, such as regular maintenance and tenant interactions. 
2. Profit motive: You need a clear intention to generate profit with business-like operations.
3. Material participation: You need regular, continuous, and substantial involvement and document your time investment.

The IRS has safe harbor provisions that provide a pathway for rental real estate enterprises to qualify as a trade or business under Section 199A. These require:

• Separate books and records for each property
• Detailed income and expense tracking
• Dedicated bank accounts

Multiple businesses and Section 199A

For taxpayers with multiple businesses, knowing how to calculate, combine, and track various business interests is very important. Managing multiple businesses under Section 199A requires attention to three key areas: 

QBI netting rules

When you own multiple businesses, all qualified business income must be netted across your enterprises. This means positive QBI from one business offsets negative QBI from another, with the net amount determining your overall deduction eligibility. 

For example, if Business A generates $50,000 in QBI while Business B has a loss of $30,000 in QBI, your net QBI would be $20,000.

Loss carryover rules

The handling of losses under Section 199A follows specific rules that affect both current and future year calculations. When your total QBI is negative in a given year, this loss must be carried forward to reduce your QBI in the following year. 

Aggregation rules

The IRS allows certain related businesses to aggregate for Section 199A purposes, which can provide benefits in meeting wage and property tests. To qualify for aggregation, businesses must share at least 50% common ownership, operate on the same tax year, and cannot be SSTBs. 

Additionally, they must meet two of three relationship tests: 

• Offering similar products or services
• Sharing facilities or business elements
• Operating in coordination with each other

Once you elect to aggregate businesses, you must maintain this treatment consistently in future years and provide annual disclosure.

Common pitfalls to avoid with Section 199A deductions

The complexity of the Section 199A deduction creates numerous opportunities for errors. Understanding common pitfalls can help you avoid costly mistakes and potential penalties. To protect yourself and your business, understand the following:  

• Documentation requirements: Maintaining records is a key part of Section 199A compliance. Essential income documentation includes profit and loss statements, bank statements, sales receipts, invoices, and 1099 forms. 
• Correctly calculating your deduction: The IRS takes Section 199A compliance seriously and can impose significant penalties for miscalculations. Accuracy-related penalties include a 20% charge on tax underpayment, with additional penalties for gross misstatements. 
• Conducting regular self-audits: Do this to review qualification criteria, check calculation accuracy, verify documentation completeness, and assess potential red flags.

Keep records for at least seven years and document all calculation methods. And the foundation of Section 199A rules starts with the domestic business requirement: 

Only income generated within the US qualifies. Foreign-sourced income and operations conducted outside US borders are explicitly excluded from consideration.

Find peace of mind come tax time

Filing taxes doesn’t have to be a headache when you know which tax deductions you qualify for. Consider checking out our small business taxes checklist to learn about everything you need to successfully file your next tax return.