S Corporation Election - Part 3 - QBI

QBI deduction: what business owners should know

The qualified business income (QBI) deduction allows eligible owners of sole proprietorships, single-member LLCs, partnerships, and S corporations to deduct a percentage of qualified business income. Under prior law, the deduction was generally up to 20% and was scheduled to expire after 2025.

A note for SSTB businesses

If you are in a specified service trade or business (SSTB), your structure decision gets more nuanced. SSTBs generally include fields such as health, law, accounting, consulting, financial

services, and other service-based professions identified under the Section 199A rules.

Above certain taxable income levels, SSTBs can face limits or lose access to the QBI deduction which can be valuable.

That does not mean an S election is bad for SSTBs. It just means you should not assume the QBI deduction will always be available the way it might be for a non-SSTB business which will factor into the decision to make the S election. For SSTB owners, the S election analysis is often more about:

• employment tax savings

• reasonable compensation

• retirement planning

• state tax impact

What changed under OBBBA?

According to the House section-by-section summary and the IRS’s OBBBA resource page:

• the QBI deduction was made permanent (yay for business owners)

• the phase-in rules for wage and investment and SSTB limitations were modified

• minimum deduction of $400 that is indexed for inflation for qualified businesses

  
  

Why this matters for S corporations

An S-election does not create QBI by itself. But S corporations are one of the pass-through entity types that may generate QBI. At the same time, owner wages do not count as QBI, so compensation planning matters. If you pay yourself too much, you may reduce the pass-through income eligible for the deduction. If you pay yourself too little, you may create payroll tax risk. That balancing act is one reason good entity planning matters.

FAQ

1. Do S corporations qualify for the QBI deduction?

Yes. S corporations are eligible pass-through entities for purposes of the QBI deduction.

2. Does an owner’s W-2 salary count toward QBI?

No. Reasonable compensation paid to an S corporation owner is excluded from QBI.

3. Can high-income owners lose the deduction?

Yes. The deduction may be reduced or eliminated at higher income levels, especially for specified service trades or businesses.

4. Does forming an S corporation guarantee a QBI deduction?

No. The deduction depends on the owner’s overall taxable income, the nature of the business, and how the income is structured.

5. Why does this matter for S corporation planning?

Because the S election may reduce self-employment tax exposure, but shareholder wages can also reduce QBI. The real tax benefit depends on balancing both rules carefully.

Conclusion

The Qualified Business Income deduction is another important limitation to consider. For service-based businesses that fall under the Specified Service Trade or Business rules, the QBI deduction may be significantly reduced or fully phased out at higher income levels, which can lessen the expected tax benefit of an S corporation election.

Curious whether your business is in the right structure?

Book a 1-hour tax strategy session with Meliora Consulting, and we can walk through your current entity structure, tax position, QBI deduction, and whether an S election actually makes sense for your business.

Meliora Consulting PLLC | tax advisory