How Do I Know If I Qualify for a 199A Deduction?

The Section 199A deduction can be one of the most valuable tax breaks for your pass-through business clients, but determining who qualifies is notoriously complex. This powerful deduction allows owners of sole proprietorships, partnerships, and S corporations to deduct up to 20% of their qualified business income (QBI). This article will walk you through the key tests and thresholds you need to understand to confidently determine if your business or your client's business is eligible for the QBI deduction.

What Exactly is the Section 199A Deduction?

First, let's establish a clear baseline. The Section 199A deduction, also known as the Qualified Business Income (QBI) deduction, was created by the Tax Cuts and Jobs Act of 2017. Its purpose was to give businesses structured as pass-through entities a tax benefit similar to the significant corporate tax rate reduction that C corporations received.

Put simply, it allows eligible taxpayers to deduct up to 20% of their QBI, plus 20% of qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income. The deduction is taken “below the line,” which means it reduces a taxpayer’s taxable income but not their adjusted gross income (AGI).

Before diving into the complex limitations, keep three key terms in mind:

• Pass-Through Entity: A business structure where income is not taxed at the company level but is instead "passed through" to the owners' individual tax returns. This includes sole proprietorships (Schedule C), partnerships, S corporations, and certain trusts and estates.
• Qualified Business Income (QBI): This is the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business. It represents the "profit" of the business but has several important considerations for tax professionals when calculating it.
• Specified Service Trade or Business (SSTB): This is a specific category of businesses, primarily in professional services, that face stricter limitations for the 199A deduction.

The Three Foundational Qualification Tests

Before you even think about income thresholds or complex limitations, every business must pass three initial screening tests. If the answer to any of these is "no," the discussion ends there—the business does not qualify.

1. Is it an Eligible Pass-Through Entity?

The 199A deduction is exclusively for pass-through businesses. This means the income must come from one of the following structures:

• Sole proprietorships (filing a Schedule C)
• Partnerships (including multi-member LLCs taxed as partnerships)
• S corporations (including LLCs that have made an S-corp election)
• Trusts and estates

Notably, C corporations are not eligible. Their income is taxed at the corporate level and does not qualify for the 199A deduction on shareholders’ personal returns.

2. Is the Activity a Qualified "Trade or Business"?

The income must be generated from a "trade or business" as defined under Section 162 of the Internal Revenue Code. While the IRS doesn't provide a perfect, all-encompassing definition, a trade or business is generally an activity conducted with regularity and continuity, with the primary purpose of generating income or profit. An activity pursued merely as a hobby does not qualify.

The key distinction here is between an active business and passive investing. For example, managing your personal stock portfolio, no matter how actively, is not considered a trade or business for 199A purposes. However, a properly structured rental real estate enterprise can qualify. Under a safe harbor provision (Rev. Proc. 2019-38), a rental activity is treated as a trade or business if it meets specific requirements, such as maintaining separate books and records and having 250 or more hours of rental services performed per year.

3. Does the Business Generate Qualified Business Income (QBI)?

QBI is the starting point for the deduction calculation. It’s the net income from a qualified domestic business, but it's not simply the bottom line on a P&L statement. QBI specifically excludes certain types of income:

• W-2 Income: Income you earn as an employee is not QBI.
• Reasonable Compensation for S Corp Owners: The salary an S corporation owner pays themselves is excluded from QBI. Only the net profit distributed after that salary is paid counts.
• Guaranteed Payments to Partners: Payments made to a partner for services rendered without regard to the partnership's income are also excluded.
• Investment Income: QBI does not include capital gains, dividends, or interest income unless it is properly allocable to the trade or business (e.g., interest income for a bank).

For example, if an S Corp has $200,000 in net profit before paying its sole shareholder-employee, and the owner takes a reasonable salary of $80,000, the QBI is the remaining $120,000. The $80,000 salary is subject to regular income and payroll taxes and is not part of the 199A calculation.

Taxable Income Thresholds: Where the Rules Get Complicated

Once you've confirmed the activity is in a pass-through entity, is a qualified trade or business, and generates QBI, the next step is to look at the taxpayer's taxable income. This is where the rules diverge into three distinct paths. For 2024, the key income thresholds are:

• Lower Threshold: $191,950 for Single, Head of Household, and Married Filing Separately filers; $383,900 for Married Filing Jointly.
• Upper Threshold: $241,950 for Single, Head of Household, and Married Filing Separately filers; $483,900 for Married Filing Jointly.

Path 1: Taxable Income is Below the Lower Threshold

This is the simplest scenario. If the taxpayer's total taxable income (before the QBI deduction) is below $191,950 (or $383,900 for MFJ), the calculation is straightforward. They generally qualify for the full 20% deduction on their QBI. The complex limitations related to W-2 wages, property, and whether the business is an SSTB do not apply. This is a massive simplification for many small businesses. A lawyer, a doctor, or a consultant with taxable income below this threshold gets the full deduction.

Path 2: Taxable Income is Above the Upper Threshold

Once taxable income exceeds $241,950 (or $483,900 for MFJ), the rules become very restrictive, especially for certain professions.

• If the business is an SSTB, the 199A deduction for that business is $0. It is completely disallowed.
• If the business is not an SSTB, the deduction is allowed but is limited to the greater of:
  1. 50% of the W-2 wages paid by the business, OR
  2. 25% of the W-2 wages paid by the business PLUS 2.5% of the unadjusted basis immediately after acquisition (UBIA) of all qualified property.

This limitation is designed to ensure the tax break benefits businesses that create jobs (W-2 wages) or make significant capital investments (UBIA).

Path 3: Taxable Income is Within the Phase-in Range

If taxable income falls between the lower and upper thresholds, the limitations are gradually phased in. This is the most complex calculation. If the business is an SSTB, the taxpayer loses a portion of their QBI, W-2 wages, and UBIA for the calculation. For example, if a single filer's taxable income is 40% of the way through the $50,000 phase-in range ($20,000 / $50,000), they only get to count 60% of their SSTB’s QBI, wages, and property for the deduction calculation. They then apply the wage and property limits to those reduced amounts.

If the business is not an SSTB, a similar phase-in applies to the W-2 wage and UBIA limitation. You calculate the full 20% QBI deduction and then calculate the W-2 wage/UBIA limit. If the 20% QBI deduction is higher than the limit, the difference is reduced based on where their income falls in the phase-in range.

What Qualifies as a Specified Service Trade or Business (SSTB)?

As you can see, identifying an SSTB is critical for any high-income taxpayer. The IRS defines an SSTB as any trade or business involving the performance of services in the fields of:

• Health (doctors, dentists, veterinarians)
• Law
• Accounting
• Actuarial Science
• Performing Arts
• Consulting
• Athletics
• Financial Services
• Brokerage Services

It also includes any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. This "reputation or skill" clause sounds broad, but the regulations have narrowed its scope primarily to situations where a person receives fees for product endorsements, licensing their personal image, or appearance fees. Architects and engineers are explicitly excluded from the SSTB definition.

There is also a de minimis rule to help companies that only offer a small amount of specified services. A business is not considered an SSTB if:

• Its gross receipts are $25 million or less, and less than 10% of those receipts come from SSTB activities.
• Its gross receipts are more than $25 million, and less than 5% of those receipts come from SSTB activities.

A Closer Look at the W-2 Wages and UBIA Limitation

For taxpayers above the income threshold, understanding this limitation is essential. Let’s break down the two components.

W-2 Wages: This is the total amount of wages subject to income tax withholding that are paid to employees during the year and reported on Form W-2. It accurately reflects the business’s payroll contribution. This is where planning for “reasonable compensation” in an S corporation becomes very important. A higher W-2 salary for the owner reduces QBI but increases the W-2 wage bucket, which could potentially increase the 199A deduction limit.

UBIA of Qualified Property: This stands for Unadjusted Basis Immediately After Acquisition. This is generally the original cost of tangible, depreciable property (like buildings, machinery, and equipment) used in the business. The property must not have reached the end of its depreciable life. This part of the formula benefits capital-intensive businesses. For example, a manufacturing plant with millions in equipment could get a significant deduction even with a modest payroll, while a consulting firm with no property would be entirely dependent on its W-2 wages.

Final Thoughts

Determining eligibility for the 199A deduction is a multi-step process that hinges on the business structure, the source and nature of its income, the taxpayer's overall taxable income, and, for high-earners, the specific industry and amount of wages paid or property owned. Working through these tests systematically is the only way to ensure your clients maximize this valuable, but complex, tax benefit.

Constantly referencing Rev. Proc. 2019-38 for real estate safe harbors or parsing the nuanced definitions of an SSTB in the regulations takes time away from actual client advisory work. That's why we built Feather AI. You can ask complex tax questions in plain English—like "Is an engineering firm with a small consulting arm an SSTB for 199A purposes?"—and get instant, clear answers backed by direct citations from the Internal Revenue Code and official IRS guidance, helping you build a defensible position for your client decisions in seconds.