Understanding (and Maximizing) the Qualified Business Income Deduction (QBID)

The qualified business income (QBI) deduction is one of the best tax planning tools out there yet most business owners have never heard of it.

We have clients who save $100k+ a year just by optimizing this.

So what is QBID?

Simply put, QBID is a tax deduction for the self-employed as well as other small business owners. The Tax Cuts and Jobs Act of 2017 created this deduction to even things out when the C Corp tax rate got lowered to 21%.

So how does it work?

It allows eligible business owners to deduct 20% of their qualified business income until their AGI hits the phaseout. Once it hits this phaseout, you get the lesser of 20% of business profits or 50% of all allocable w2 wages (unless you are an SSTB which we will talk about later).

This chart below should help you better understand the mechanics of how this works:

Let’s look at a simple example for a business doing $200,000 in profit. .

If you own a business that will do $200k in profit, you would then get 20% of that profit ($200k) as a deduction for QBID. This means you get a $40k deduction which results in tax savings of $40k x your marginal federal and state tax rate. If you are in the 22% bracket, you would save $8,800 in taxes. For people with AGI’s below the phaseout S Corps reduce QBID since you add wages and reduce profit. The goal is to have a lower salary, but one that is reasonable to stay compliant.

A few points to note:

You can take the QBID deduction even if you take the standard deduction.
It does not lower self-employment taxes. It only lowers your income taxes.
It can impact retirement planning. You cannot apply the 20% QBI deduction to money that is put into a pre-tax retirement plan. So if you add to the employer side 401(k), SEP IRA, etc., it lowers your profit which will lower QBID. This does not mean you should not do it, but just be aware as it makes the tax benefits a little less impactful. Think about it, if you had $200k in profit that would be $40k deduction. But if you put $20,000 in a SEP IRA, then profit becomes $180,000 which results in $36,000 vs $40,000 as the deduction.

Who qualifies for QBID and At What Income Levels?

For 2024, if you are a single filer, you must be under $191,950 to fully qualify. And if married filing jointly, then you need to be under $383,900 to fully qualify. These numbers are indexed to inflation each year so this should change for 2025. If you are above those numbers, the deduction starts to phase out and you only get a partial deduction. Then there is a higher QBID threshold. If you are above $483,900 (married) or $241,950 single and are an SSTB then you get no deduction. If you are above it, but not an SSTB, then you can do the LESSER of:

50% of W-2 wages paid
Or 25% of W-2 wages paid + 2.5% of depreciable property

So what does SSTB mean? It means businesses who are deemed “a specified service trade or business” (SSTB). Businesses like financial planners, lawyers, doctors, consultants, etc. Basically anyone who is paid or hired due to their name, image and likeness.

Let’s look at another example, a business doing $1,000,000 in profit before wages.

No Planning: Non S Corp

Let’s say you own a business that will do $1mil in profit this year and you are not an S Corp and you are the only employee. Since your income is that high, you have to take the lesser of 20% of business profits of 50% of W2 wages.

Wages = $0
Profits = $1mil x 20% = $200k

Since it is the lesser, you have to take the $0 deduction. This is why for many high profit businesses, S Corps start to become very advantageous.

No Planning: S Corp

Same example as above but instead you get told to pay yourself the lwoerst reasonable salary to minimize self employment taxes (most only know about that part) so you do $100k in wages and then have $900k of profit.

$100k Wages = $50k
Profits = $900k x 20% = $180,000

Since it is the lesser, you have to take the $50k deduction. I hope you can see here that so much is left on the table due to not doing the planning needed.

Proper Planning

Let’s stick with the same example as an S Corp that has $900k of profit and $100k of wages.

Wages = $100k x 50% = $50k
Profits = $900k x 20% = $180,000

December rolls around and this is the perfect time to optimize QBID by running a bonus. A great way to do this is by using the 2/7ths rule. This is where you add up wages and profit and multiplying it by 2/7ths.

$900k + $100k =- $1mil

2/7 * $1mil - $285,700

So the optimal wages would be $285,700.

Wages: $285,700 x 50% = $142,857
$1mil of profit - $285,700 of wages = $714,285 of profit x 20% = $142,857

This planning leads to you getting a $142,857 deduction vs the example above of $50k, all because you did the planning correctly at year end and got wages to the optimal number. That is over $90k of additional deductions which saves anywhere from $20k-$45k based on state and tax bracket. So few actually do this planning at year end and run bonuses to fine tune the deduction.

You need to plan around QBID!

How To Optimize For QBI?

There is a lot to go through here, but for the sake of this post we are just going to focus on some planning topics that can be considered to maximize your QBI deduction:

If you are over the taxable income threshold, consider deferring income or accelerating expenses this year to maximize it (cash balance plan, 401(k) profit share, SEP IRA, etc).
If over the income threshold, consider adding pre-tax retirement accounts to lower your income (SEP IRA, Solo 401(k), etc).
Consider using a 401(k) vs SEP IRA since you can get in the whole employee side without reducing profits
Employee your spouse or older children to reduce profit if you are profit heavy
Setup an S Corp and pay yourself a salary if you are over the phaseout. Remember as I pointed out above, you can take the lesser of 20% of profits or 50% of wages. If you have no wages, you get no deduction.
Use the 2/7 rule which can help you figure out the right salary. It basically means you pay yourself 2/7 of the profit (once salaries are added back in) to get this to net out for the best deduction.