The 20% Pass-Through Tax Deduction for Business Owners

A few years ago, Congress established a new income tax deduction for owners of pass-through businesses, including sole proprietorships, partnerships, S corporations, limited liability companies (LLCs), and limited liability partnerships (LLPs). This deduction is commonly referred to as the "pass-through deduction" or "qualified business income" (QBI) deduction.

Pass-through business owners who qualify can deduct up to 20% of their net business income from their income taxes, reducing their effective income tax rate by 20%. The deduction was intended to avoid placing pass-through owners at a disadvantage compared with regular C corporations, whose tax rate was lowered to a flat rate of 21% by the Tax Cuts and Jobs Act.

Originally enacted as a temporary measure and scheduled to expire after 2025, the One Big Beautiful Bill Act made the pass-through deduction permanent.

What Is the 20% Qualified Business Income (QBI) Deduction?

Pass-through owners who qualify can deduct up to 20% of their net business income from their income taxes, reducing their effective income tax rate by 20%. This deduction is commonly known as the "qualified business income deduction" or "QBI deduction."

This deduction can really add up. For example, if you have $100,000 in pass-through income, you could qualify to deduct $20,000, reducing your income taxes by a whopping $4,400 if you're in the 22% income tax bracket.

Clearly, all small business owners need to understand this complex deduction.

What Businesses Qualify for the QBI Deduction?

You must have a pass-through business to qualify for this deduction. A "pass-through business" is any business that is owned and operated through a pass-through business entity, which includes any business that is:

• a sole proprietorship (a one-owner business in which the owner personally owns all the business assets)
• a partnership
• an S corporation
• a limited liability company (LLC), or
• a limited liability partnership (LLP).

What Is a Pass-Through Business?

For tax purposes, what distinguishes these types of businesses is that they pay no taxes themselves. Instead, the profits (or losses) from such businesses are passed through the business, and the owners pay tax on the money on their individual tax returns at their individual tax rates.

The vast majority of smaller businesses are pass-through entities. Indeed, over 86% of businesses without employees are sole proprietorships.

What About C Corporations?

Regular "C" corporations don't qualify for this deduction. However, they do qualify for a low 21% corporate tax rate on all their income. Unlike the pass-through deduction, the 21% rate for C corporations is permanent under the TCJA.

You Must Have Qualified Business Income

Again, individuals who earn income through pass-through businesses may qualify to deduct from their income tax an amount equal to up to 20% of their "qualified business income" (QBI) from each pass-through business they own. (I.R.C. Sec. 199A (2025).)

What Is QBI?

QBI is the net income (profit) your pass-through business earns during the year. You determine this by subtracting all your regular business deductions from your total business income. QBI includes rental income so long as your rental activity qualifies as a business (as most do).

It also includes income from publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives.

What Is Not Considered QBI?

QBI doesn't include:

• short-term or long-term capital gain or loss—for example, a landlord would not include capital gain earned from selling a rental property
• dividend income
• interest income
• wages paid to S corporation shareholders
• guaranteed payments to partners in partnerships or LLC members, or
• business income earned outside the United States.

How to Determine Your QBI

QBI is determined separately for each separate business you own. If you own multiple businesses that aren't service businesses listed below, you have the option of combining them into one for the deduction, but only if at least two of the following requirements are satisfied:

• the businesses provide products or services that are the same or customarily offered together or

• the businesses share facilities or significant centralized business elements, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources or
• the businesses are operated in coordination with, or reliance upon, one or more of the businesses in the combined group.

If one or more of your separate businesses lose money, you deduct the loss from the QBI of your profitable businesses. If you have a qualified business loss—that is, your net QBI is zero or less—you get no pass-through deduction for the year. Any loss is carried forward to the next year and is deducted against your QBI for that year.

How Do I Calculate My QBI Deduction?

To determine your pass-through deduction, you must first figure your total taxable income for the year (not counting the pass-through deduction). This is your total taxable income from all sources (business, investment, and job income) minus deductions, including the standard deduction ($15,750 for singles and $31,500 for marrieds filing jointly in 2025).

You Must Have Taxable Income

You must have positive taxable income to take the pass-through deduction. Moreover, the deduction can never exceed 20% of your taxable income.

20% Deduction for Taxable Income Below Annual Threshold

How the pass-through deduction is calculated depends on whether your taxable income (QBI income plus other taxable income) exceeds an annual threshold that is adjusted for inflation each year.

Deduction for Taxable Income Up to $197,300 ($394,600 If Married)

If your 2025 taxable income is at or below $197,300 if single or $394,600 if married filing jointly, your pass-through deduction is equal to 20% of your QBI. However, as discussed above, the deduction may not exceed 20% of your taxable income.

If your taxable income is at or below the $197,300/$394,600 thresholds, that's all there is to the pass-through deduction. You're effectively taxed on only 80% of your business income.

Starting in 2026, there is a minimum pass-through deduction. If you have at least $1,000 in QBI, your deduction must be at least $400. This change will benefit those with QBIs of $1,000 to $2,000.

Deduction for Income Above $197,300 ($394,600 If Married)

If your 2025 taxable income exceeds $197,300 if single or $394,600 if married, calculating your deduction is much more complicated and depends on your total income, the type of work you do, and whether you have employees or business property.

Are You a Specified Service Business?

First, you need to determine whether your business is a "specified service trade or business" (SSTB). Several specific types of business activities are SSTBs:

• health (doctors, dentists, and other health fields)
• law
• accounting
• actuarial science
• performing arts
• consulting
• athletics
• financial services
• brokerage services (not including real estate or insurance brokers)
• investing and investment management (not including property managers), or
• trading and dealing in securities or commodities.

A final catchall category includes any business where the principal asset is the reputation or skill of one or more of its owners or employees. IRS regulations narrowly define this catchall category to include only cases where a person:

• receives fees or other income for endorsing products or services

• licenses his or her image, likeness, name, signature, voice, or trademark, or

• receives fees or other income for appearing at an event or on radio, television, or another media format.


Architecture and engineering services are expressly not included in the list of personal services. Also not included are real estate brokers, real property managers, and insurance brokers.

If the same business sells products or merchandise and also provides services that fall within one of the SSTB categories, the business will not be treated as an SSTB so long as less than 10% of the gross receipts of the business come from providing the service.

Deduction for Non-Service Businesses (Income Above $197,300/$394,600)

If your business isn't included in the list of specified service businesses, and your 2025 taxable income is over the $197,300/$394,600 thresholds, how you figure your pass-through deduction depends on your taxable income.

Taxable Income Above $247,300 ($494,600 If Married). If your 2025 taxable income exceeds $247,300 (single) or $494,600 (married filing jointly), your maximum possible pass-through deduction is 20% of your QBI, just like at the lower income levels. However, when your income is this high, a W-2 wage/business property limitation takes full effect. Your deduction is limited to the greater of:

• 50% of the W-2 employee wages paid by your business, or
• 25% of W-2 wages plus 2.5% of the acquisition cost of your depreciable business property.

So, if you have neither employees nor depreciable property, you get no deduction. W-2 wages means the total wages and benefits reported by the employer to the Social Security Administration.

Taxable Income $197,301 to $247,300 ($394,601 to $494,600 If Married). If your 2025 taxable income is $197,301 to $247,300 (single) or $394,601 to $494,600 (married filing jointly), the W-2 wages/property limitation is phased in—that is, only part of your deduction is subject to the limit and the rest is based on 20% of your QBI. The phase-in range is $50,000 for singles and $100,000 for marrieds.

For example, the limit would be 50% phased in for married taxpayers with taxable income of $444,600 ($50,000 over $394,600, which equals 50% of the $100,000 phase-in range). At the top of the income range ($247,300 for singles, $494,600 for marrieds), your entire deduction is subject to the W-2 wages/business property limit. So, if you have no W-2 wages or business property, you get no deduction.

To calculate the phase-in, first determine what the amount of your deduction would be if the W-2 wages/property limit didn't apply at all—this is 20% × your QBI. Next, calculate your deduction as if the W-2 wages/property limit applied in full. Your phase-in amount is based on the difference between these two calculations multiplied by your phase-in percentage.

Starting in 2026, the phase-in range increases to $75,000 for singles and $150,000 for marrieds filing jointly, which is a $25,000 increase for singles and $50,000 for marrieds. So, for singles, the phase-in range will be approximately $197,301 to $272,300, and it will be $394,601 to $544,600 for marrieds filing jointly. These numbers are approximate because they will be adjusted for inflation in 2026 and later. This change will enable singles to earn $25,000 more in taxable income and marrieds to earn $50,000 more without being fully subject to the W-2 wages/property limit.

Deduction for Specified Service Business Owners (Income Above $197,300/$394,600)

If your business is a specified service business, and your 2025 taxable income exceeds $197,300 (single) or $394,600 (married), your pass-through deduction is gradually phased out up to $247,300/$494,600 of QBI. At the top of the income range, you get no deduction at all. That is, if your total income exceeds $247,300 (single) or $494,600 (married), you get no deduction. This was intended to prevent highly compensated employees who provide personal services from having their employers reclassify them as independent contractors so they could benefit from the pass-through deduction. There is no such phaseout of the entire deduction for non-service providers.

To calculate your deduction, you start by using the same formula as for non-service providers discussed above. Your maximum possible deduction is 20% of your QBI. However, your deduction may not exceed the greater of:

• 50% of your share of W-2 employee wages paid by the business, or
• 25% W-2 wages plus 2.5% of the acquisition cost of depreciable property used in the business.

So, if you have no employees or depreciable business property, you get no deduction.
Next, you calculate the phaseout of the deduction. If you're married and have employees or property, your deduction is phased out by 1% for every $1,000 your 2025 income exceeds the $394,600 threshold. When your income reaches $494,601, if you're married, you get no deduction. If you're single, your deduction is reduced by 2% for every $1,000 your income exceeds the $197,300 threshold and you get no deduction if your income reaches $247,301 or more.

Starting in 2026, the phase-in range for specified service business owners also goes up to $75,000 for singles and $150,000 for marrieds filing jointly. This change will enable singles to earn $25,000 more in taxable income and marrieds to earn $50,000 more without losing their pass-through deduction. In 2026 and later, the deduction for singles will be phased out by 1.33% for every $1,000 their taxable income exceeds the threshold, and 0.66% for marrieds filing jointly.

Chart of Pass-Through Deduction Thresholds, Limits, and Phase-Ins (2025)

Taking the QBI Deduction

The pass-through QBI deduction is a personal deduction you may take on your Form 1040, whether or not you itemize. It isn't an "above the line" deduction on the first page of Form 1040 that reduces your adjusted gross income (AGI). Moreover, the deduction only reduces income taxes, not Social Security or Medicare taxes.

Get More Information

For more information on this and other tax issues for small businesses, get Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).

If you need more help, talk to a tax professional, such as a certified public accountant or a tax attorney. A tax professional can prepare tax returns or provide tax information, guidance, or representation before the IRS.