The qualified business income (QBI) deduction under Section 199A lets many S-corporation shareholders exclude up to twenty percent of their pass-through profit from federal income tax. Created in 2017 and broadened in 2025, it is one of the most powerful—and most misunderstood—breaks available to closely held companies.
Eligibility hinges on taxable-income thresholds, the way an owner splits salary and profit, and whether the business is classified as a “specified service trade or business” (SSTB). Because the rules are nuanced and can change with new legislation, the discussion below is educational only and should not be treated as legal or tax advice; always work with a qualified professional before relying on any strategy.
What Is the Section 199A QBI Deduction?
Origin and Purpose of Section 199A
Congress enacted Section 199A in the 2017 Tax Cuts and Jobs Act to keep pass-through firms competitive after C-Corporations received a permanent tax rate rate cut to twenty-one percent. By allowing owners of sole proprietorships, partnerships, S-Corps, and certain trusts or estates to deduct a slice of profit, lawmakers aimed to neutralize the disparity.
The provision was originally temporary. However, it was made a permanent feature of the U.S. tax code in the One Big Beautiful Bill Act of 2025.
Who Can Potentially Claim It?
Any individual with “qualified business income” from an eligible trade or business may benefit. That pool includes sole proprietors, partners, S-Corp shareholders, some beneficiaries of estates and trusts, and even certain landlords who meet the trade-or-business standard.
For S-Corp owners, the critical concept is that their corporation itself does not take the deduction; it flows through and is claimed on the shareholder’s Form 1040.
The Basic Twenty-Percent Formula
At its simplest, Section 199A lets a qualifying taxpayer deduct up to twenty percent of QBI. QBI equals the net amount of qualified items of income, gain, deduction, and loss connected with the business.
Salary that an S-Corp owner receives as a W-2 employee does not count; only the K-1 flow-through profit is eligible. Likewise, capital gains, dividend income, and interest income (other than from the business lending activity) are excluded.
How Section 199A Works Specifically for S-Corp Owners
Understanding Qualified Business Income in an S-Corp
When an S-Corp earns money, the owner usually extracts it two ways. First is a W-2 wage the corporation pays for services rendered. Second is distributable profit that shows up on the shareholder’s Schedule K-1. Only the latter counts as QBI. Pre-tax adjustments—such as the corporation’s contributions to the shareholder’s health insurance or retirement plan—lower the K-1 amount and thereby reduce QBI.
Conversely, deductions taken on the individual return after QBI is determined, such as the self-employed health-insurance adjustment, do not change QBI but do affect taxable income, which drives phase-outs.
The Importance of Reasonable Compensation
The Internal Revenue Code requires S-Corp shareholder-employees to take a “reasonable” wage before dividends. Pay too little and the IRS may reclassify distributions as wages, generating back payroll taxes and penalties.
Pay too much and the enlarged salary both raises payroll-tax cost and shrinks QBI, reducing or eliminating the Section 199A benefit. Smart planning pegs salary at the low end of the defensible range, balancing evidence such as industry norms, duties performed, and time devoted.
How the Deduction Shows Up on the Tax Return
From a compliance standpoint, the S-Corp files Form 1120-S. Schedule K-1 reports each shareholder’s share of the corporation’s QBI items, W-2 wages paid, and unadjusted basis of qualified property.
On the individual side, the shareholder carries those figures to Form 8995 (simpler cases) or Form 8995-A (complex cases) and then claims the resulting deduction on Form 1040, line 13. The S-Corp therefore lowers the owner’s personal tax—not its own entity-level tax—through this mechanism.
Income Thresholds, Phase-Outs, and SSTBs
Taxable Income Thresholds for Section 199A
For 2025, the full twenty-percent deduction is available when taxable income after adjustments is at or below $394,600 for married joint filers and $197,300 for single, head-of-household, and married-filing-separate taxpayers. Once income exceeds those levels, a phase-in of limitations begins and is fully effective at $494,600 and $247,300, respectively.
The moment a return crosses the lower threshold, computations shift from the straightforward twenty-percent rule to formulas that consider W-2 wages, qualified property, and possibly SSTB status.
Specified Service Trades or Businesses (SSTBs)
A Specified Service Trade or Business includes fields such as health, law, accounting, consulting, financial services, athletics, performing arts, and any business where the principal asset is the reputation or skill of one or more employees or owners. For SSTBs, the deduction is fully available below the threshold, but phases out rapidly within the next $100,000 (joint) or $50,000 (other filers) of income, disappearing entirely once the top range is reached.
A physician whose S-Corp income pushes the couple’s taxable income to $500,000 receives no deduction, whereas a furniture-manufacturing S-Corp at the same income level may still qualify, subject to wage and property tests.
W-2 Wages and Qualified Property Limitations
Above the threshold, even non-SSTB owners face guardrails. The deduction is limited to the greater of fifty percent of W-2 wages paid by the business, or the sum of twenty-five percent of W-2 wages plus two-and-a-half percent of the unadjusted basis of qualified, depreciable property still in service.
This design encourages owners to pay employees (including themselves) fair wages and to invest in equipment or real property that stays on the books.
Practical Examples of 199A for Different S-Corp Scenarios
Example 1 – S-Corp Owner Below the Income Threshold
Amelia runs a small graphic-design S-Corp that earns $120,000 after expenses. She pays herself $60,000 in reasonable salary and takes the remaining $60,000 as a distribution. Assuming her only other income is a $5,000 bank-interest line item, her taxable income is well below the 2025 single-filer threshold. Her QBI equals the $60,000 distribution.
Section 199A lets her deduct $12,000 (twenty percent of $60,000), trimming her federal tax by roughly $2,640 if she sits in the twenty-two-percent bracket. Without the deduction, she would pay that extra tax.
Example 2 – S-Corp Owner Above the Threshold, Non-SSTB
Ben and Maya jointly own a light-manufacturing S-Corp that generates $700,000 of profit before owner wages. Each draws a $150,000 salary, leaving $400,000 as flow-through profit. Their joint taxable income lands at $650,000, which triggers the wage-and-property limitation. The company pays a total of $600,000 in W-2 wages (including the owners’ salaries) and holds $1,000,000 of depreciable machinery with $400,000 unadjusted basis.
The 199A deduction equals the lesser of twenty percent of QBI ($80,000) or the wage/property cap: greater of fifty percent of wages ($300,000) or twenty-five percent of wages plus 2.5 percent of qualified property ($170,000). Because both caps exceed $80,000, they still receive the full $80,000 deduction.
Example 3 – S-Corp Owner Above the Threshold, SSTB
Cara, a solo CPA whose practice is an SSTB, earns $500,000 net after expenses in her S-Corp. She pays herself $160,000 salary and reports $340,000 on the K-1. With no spouse and modest investment income, her taxable income is $515,000—over the $247,300 single-filer top phase-out.
In consequence, her Section 199A deduction is completely disallowed. If she maximized her solo 401(k) deferral, added a defined-benefit pension plan, and accelerated deductible expenses, she might push taxable income below $247,300 and reclaim a partial deduction.
Planning Strategies for S-Corp Owners Around Section 199A
Optimizing Salary vs. Distributions
Reasonable-compensation studies often produce ranges rather than a single bulletproof figure. Choosing a salary toward the lower, defendable edge increases QBI, but never so low that it triggers an IRS re-characterization.
Adjusting salary even by a few thousand dollars can materially change both payroll-tax liability and the 199A figure. Owners should document duties, time devoted, and industry benchmarks to support the chosen number.
Managing Taxable Income Levels
Because Section 199A measures eligibility against taxable income, not merely business profit, holistic planning counts. Large retirement-plan contributions—solo 401(k), SEP-IRA, or even a cash-balance plan—can pull a high-earning owner back into a favorable range.
Health Savings Account deposits, timing of equipment purchases eligible for bonus depreciation, and charitable-giving strategies accomplish the same goal. For families with children active in the company, paying legitimate wages to the next generation both shifts income to lower brackets and increases the corporation’s W-2 pool for wage-limit purposes.
Entity Structure and Multi-Business Owners
Entrepreneurs who operate several ventures must examine the IRS aggregation rules that allow, or in some cases require, grouping of multiple activities. Aggregating a capital-intensive enterprise with a labor-only operation can boost the combined wage/property ceiling, yet “crack-and-pack” attempts to split an SSTB into separate entities to sidestep the rules generally fail.
Sometimes placing real estate in a separate entity and renting it to the operating S-Corp supplies additional W-2 wages or property basis, but only if done at arm’s length with proper documentation.
Coordination With Other Tax Benefits
Section 199A rarely stands alone. A proper plan may weigh 199A against the choice to take the standard deduction or to itemize, compare Roth versus pre-tax retirement contributions, and consider business credits such as the research-and-experimentation credit.
Owners benefit most when 199A is viewed as one piece in a broader mosaic of cash-flow management, risk reduction, retirement funding, and wealth-transfer objectives.
Common Mistakes S-Corp Owners Make With Section 199A
Confusing QBI With Gross Receipts or Total Income
Some taxpayers erroneously calculate twenty percent of top-line revenue, or of profit before officer wages, or of taxable income. QBI starts after ordinary deductions but before owner-specific adjustments such as the self-employed health-insurance deduction. Mis-measuring almost always leads to either leaving money on the table or risking an IRS adjustment.
Ignoring SSTB Status or Misclassifying the Business
An S-Corp attorney who claims full deduction while over the threshold and asserts the firm is “consulting” rather than legal services invites scrutiny. The definitions are broad, and IRS exam guidance instructs agents to look at the substance of revenue sources. A wrong classification can result in retroactive disallowance plus interest and penalties.
Over- or Under-Paying Owner Wages
A tech founder who pays herself $20,000 salary on $400,000 profit may enjoy lower payroll tax and higher QBI—until the IRS re-characterizes the bulk of distributions as wages, which demolishes not only the Section 199A deduction but also adds back payroll taxes with penalties.
Conversely, a dentist who takes a $300,000 salary on $500,000 production profit forfeits QBI unnecessarily. Methodical compensation analysis is essential.
DIY Filing Without Understanding Form 8995/8995-A
Commercial software asks for inputs such as W-2 wages and qualified-property basis. If those boxes are left blank or mis-keyed, the program cannot compute the wage/property limitation, and the deduction might default to zero. Returns that use the simplified Form 8995 when Form 8995-A is required often under-state the benefit. Owners must ensure the preparer—or the DIY software user—feeds accurate data.
When S-Corp Owners Should Seek Professional Guidance
Signs You Need a Tax Advisor
If your taxable income approaches or exceeds the threshold, your business potentially falls into an SSTB category, you operate multiple entities, or your compensation arrangement changes mid-year, professional help becomes essential. Owners contemplating large asset purchases, stock redemptions, or ownership changes should likewise seek advice before year-end.
How Ongoing Planning Beats Once-a-Year Tax Prep
Quarterly or mid-year meetings allow owners to tweak wages, make elective retirement contributions, or time large purchases while options still exist. Documentation built contemporaneously—reasonable-salary reports, minutes approving dividends, depreciation schedules—bolsters any position the return ultimately takes.
Partner With Experts Who Understand the Stakes
Navigating Section 199A is just one facet of running a closely held company, but the dollars at stake merit attention. Small Business Taxes LLC offers comprehensive tax and accounting services for small businesses that integrate owner compensation, retirement-plan design, and entity strategy so entrepreneurs keep more of what they earn while staying compliant.
Reach out today to explore a personalized roadmap before the calendar—and perhaps the deduction itself—runs out.
