What the QBI deduction is (and how it caps out)

• At its core, the deduction equals the sum of:

  • 20% of the net QBI from qualified trades or businesses (the “QBI component”), plus

  • 20% of qualified REIT dividends and qualified PTP income (the “REIT/PTP component”), limited to 20% of taxable income minus net capital gain Treas. Reg. § 1.199A-1(c)(1); Treas. Reg. § 1.199A-1(d)(1)

• For taxpayers above the income threshold, the QBI component is further limited to the lesser of 20% of QBI or the greater of:

  • 50% of W‑2 wages, or

  • 25% of W‑2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property Treas. Reg. § 1.199A-1(d)(2)(iv)

• QBI and REIT/PTP items are determined per trade or business and then aggregated to the deduction level and capped by taxable income before the QBI deduction and net capital gain Treas. Reg. § 1.199A-1(c)(1); Treas. Reg. § 1.199A-1(d)(1)

• The IRS notes the deduction generally applies to tax years beginning after December 31, 2017 and ending on or before December 31, 2025 IRS QBI page

What counts as “QBI” for S corporation owners

• QBI is the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business, as defined in the regulations Treas. Reg. § 1.199A-3(b)(1)-(2)

• Critically for S corporation owners:

  • “Reasonable compensation” paid to an S corporation shareholder is excluded from the shareholder’s QBI (though the S corporation’s deduction for those wages reduces the entity’s QBI) Treas. Reg. § 1.199A-3(b)(2)(H)

  • Guaranteed payments under section 707(c) do not apply to S corporation shareholders (they apply to partners), but any wages paid are not QBI to the recipient as noted above Treas. Reg. § 1.199A-3(b)(2)(H)

  • Portfolio-type items (capital gains/losses, dividends, most interest) and some other items are excluded from QBI Treas. Reg. § 1.199A-3(b)(2)

  • REIT dividends and PTP income are not QBI, but may qualify for the separate 20% REIT/PTP component Treas. Reg. § 1.199A-3(c)

• For pass-through entity owners, material participation is not required to qualify for the QBI deduction; the trade or business status is evaluated at the entity level for activities conducted by an S corporation 2024 Instructions for Form 8995-A

How S corporation status changes the analysis

1. Entity-level QBI determination; shareholder-level deduction

• The S corporation determines QBI at the corporate level (net ordinary income after allowable deductions) and passes QBI, W‑2 wages, and UBIA to shareholders, who compute the deduction on their returns Treas. Reg. § 1.199A-6(b)(2)-(3)

• Wages paid by the S corporation to shareholder-employees reduce the S corporation’s QBI (as a deduction) but are not QBI to the recipient Treas. Reg. § 1.199A-3(b)(2)(H)

• Reporting is mandatory: S corporations must separately identify and report each trade or business’s QBI, W‑2 wages, UBIA of qualified property, and whether it is a specified service trade or business (SSTB). Failure to report is presumed to be zero for positive QBI items Treas. Reg. § 1.199A-6(b)(3)(i)-(iii); 2024 Instructions for Form 1120‑S

1. W‑2 wage limitation mechanics for S corporations

• For higher-income taxpayers, the W‑2 wage limitation may cap the QBI component. “W‑2 wages” for section 199A are defined by statute and regulations and can be computed under specific IRS methods (unmodified Box method, modified Box 1 method, tracking wages method) in Rev. Proc. 2019‑11 Rev. Proc. 2019‑11

• After calculation, only wages properly allocable to QBI are included for the limitation; the wages must be reported to SSA by the 60th day after the due date for Form W‑2 to count Rev. Proc. 2019‑11; Treas. Reg. § 1.199A-2(b)

1. UBIA of qualified property

• For taxpayers above the threshold, UBIA of qualified property may supplement W‑2 wages in the limitation formula (25% of W‑2 + 2.5% UBIA). UBIA is determined at the entity level and passed through to shareholders Treas. Reg. § 1.199A-1(d)(2)(iv); Treas. Reg. § 1.199A-6(b)(2)-(3)

1. Specified Service Trade or Business (SSTB) status matters

• If the S corporation conducts an SSTB, QBI, W‑2 wages, and UBIA from that SSTB are subject to phase-out when taxable income exceeds the threshold; they are excluded entirely when taxable income is above the phase-in range Treas. Reg. § 1.199A-1(d)(2)(i); Treas. Reg. § 1.199A-5

• The S corporation must identify SSTB status for each trade or business in its reporting to shareholders Treas. Reg. § 1.199A-6(b)(3)

1. Aggregation of trades or businesses

• Owners may aggregate multiple trades or businesses (including those conducted via an S corporation) if ownership, similarity, and operational nexus tests are met (e.g., 50% common ownership and at least two of the three coordination factors). Aggregation is elective but imposes annual disclosure and consistency requirements Treas. Reg. § 1.199A-4(b)-(c)

• Aggregation allows combining QBI, W‑2 wages, and UBIA for the wage/property limitations but does not convert an SSTB into a non‑SSTB Treas. Reg. § 1.199A-4

S corporation owners: self-rentals and rentals

• Rental or licensing of tangible or intangible property to a commonly controlled trade or business qualifies as a trade or business for section 199A, even if not a section 162 trade or business (the “self-rental” rule). This can be relevant where a shareholder owns a real estate entity that rents to their S corporation Treas. Reg. § 1.199A-1(b)(14)

• Beyond self-rentals, the IRS provided a safe harbor for rental real estate enterprises to be treated as a trade or business solely for section 199A, if recordkeeping and service-hour tests are met (with exclusions like triple net leases and personal-use property) Rev. Proc. 2019‑38; IRS News Release IR‑2019‑158

How to compute the deduction at the shareholder level

• The mechanics for computing the QBI deduction are identical for individuals with pass-through income from S corporations and partnerships. If taxable income is below the threshold, the deduction is simply 20% of total QBI plus 20% of qualified REIT/PTP, capped at 20% of taxable income minus net capital gain Treas. Reg. § 1.199A-1(c)(1); Instructions for Form 8995

• If taxable income exceeds the threshold, shareholders:

  • Apply SSTB exclusions or applicable percentage reductions,

  • Apply the W‑2 wage/UBIA limitations per trade or business (or aggregated businesses),

  • Sum the QBI component across trades (post-limitations), add the REIT/PTP component, then cap the total at 20% of taxable income minus net capital gain Treas. Reg. § 1.199A-1(d)

• The IRS emphasizes: wage income reported on Form W‑2 is not QBI; however, the S corporation’s wage deduction affects the entity’s QBI. Also, there is a presumption that services performed for a former employer remain employment for three years (rebuttable by documentation), relevant to whether amounts are wage income vs. self-employment income Instructions for Form 8995-A

Reporting: what S corporations must provide to shareholders

• For each trade or business (including aggregated businesses), an S corporation must report to shareholders:

  • QBI,

  • W‑2 wages properly allocable to QBI,

  • UBIA of qualified property,

  • Whether the trade or business is an SSTB, and

  • Any qualified REIT dividends or qualified PTP income received by the S corporation Treas. Reg. § 1.199A-6(b)(2)-(3)

• If an S corporation fails to report required items, the shareholder’s positive QBI, W‑2 wage, and UBIA amounts are presumed to be zero for the deduction, underscoring the importance of complete K‑1 disclosures and attachments Treas. Reg. § 1.199A-6(b)(3)(iii)

Trusts, estates, and ESBTs holding S corporation stock

• QBI items allocated from an S corporation to a trust or estate are handled similarly to an individual’s, with QBI allocated among the trust/estate and beneficiaries based on distributable net income (DNI) proportions. ESBTs compute the QBI deduction separately for their S and non‑S portions Treas. Reg. § 1.199A-6(d)(1)-(2), (d)(3)(vi)

Compliance and penalty risk

• The accuracy-related penalty is generally 20% of underpayments; for taxpayers claiming a section 199A deduction, “substantial understatement” is triggered at 5% of the tax required to be shown (instead of 10%) or $5,000, whichever is greater IRS Accuracy-Related Penalty page; IRC § 6662(d)(1)(C) overview

Practical implications for S corporation owners

• Reasonable compensation is excluded from QBI at the shareholder level; however, paying wages adds deductible expense at the S corporation level (reducing QBI) and may increase W‑2 wages considered in the limitation for high-income owners. Balancing entity QBI, the wage limitation, and owner compensation requires careful modeling under the wage/UBIA formulas Treas. Reg. § 1.199A-3(b)(2)(H); Treas. Reg. § 1.199A-1(d)(2)(iv)

• If multiple trades or businesses are conducted within the S corporation (or across related entities), consider whether aggregation can improve the wage/property limitation outcome (subject to strict ownership and coordination tests) Treas. Reg. § 1.199A-4

• Self-rental of real property to the S corporation may be treated as a trade or business for section 199A purposes (even if not a section 162 business), and the rental safe harbor may be available (subject to exclusions like triple net leases) Treas. Reg. § 1.199A-1(b)(14); Rev. Proc. 2019‑38

• Ensure complete K‑1 and attachment reporting of QBI, W‑2 wages, UBIA, SSTB status, and REIT/PTP components to avoid presumed zeros Treas. Reg. § 1.199A-6(b)(3)(iii)

Examples in the regulations

• The regulations include worked examples illustrating wage limitations, UBIA interactions, SSTB exclusions, and entity shareholder computations (e.g., Examples 3–6 in Treas. Reg. § 1.199A-1(c)) Treas. Reg. § 1.199A-1(c); Treas. Reg. § 1.199A-1(d)

Additional IRS guidance

• IRS resource pages and instructions provide user-friendly summaries of what counts as QBI, what’s excluded, and safe harbor details (e.g., rentals). These are useful cross-checks when preparing returns and disclosures IRS QBI page; Instructions for Form 8995; Instructions for Form 8995-A

Conclusion

For S corporation owners, section 199A can be highly beneficial—but the entity’s role in determining QBI, W‑2 wages, and UBIA, and the owner’s responsibility to compute the deduction and satisfy income-based limitations, make tight compliance and careful planning essential. Pay particular attention to:

• Reasonable compensation (excluded from QBI at the shareholder level),

• The wage/property limitation at higher incomes,

• SSTB classification and reporting,

• Required S corporation K‑1 disclosures (QBI, wages, UBIA, SSTB status), and

• Documentation for rentals (including self-rentals) under the safe harbor, where applicable.

Given the reduced threshold for “substantial understatement” penalties when claiming section 199A, robust documentation and accurate reporting are critical IRC § 6662(d)(1)(C) overview.