The Section 199A deduction, aka the Qualified Business Income or QBI deduction, can be worth up to 20% of your business’ profit. Most small businesses can qualify for this deduction, but the business entity you choose can change the amount you get back. In this post, I’ll guide you through how to keep the QBI deduction as simple as possible while also maximizing the deduction for your business situation.
What is Section 199A?
Section 199A allows many small business owners to deduct up to 20% of their qualified business income (QBI). It applies to pass-through businesses, including:
This deduction was created to give a tax break to businesses that aren’t receiving a reduced corporate tax rate, so it does not apply to C-Corporations.
What is qualified business income?
To put it simply, QBI includes typical business income after deductions like self-employment tax, self-employed health insurance deductions, and deductions for retirement contributions. It doesn’t include certain types of income and losses like short-term and long-term capital gains, W-2 wages received as an employee, or income from interest or annuities.
Are there limits to the Section 199A Deduction?
One thing to note here is that the Section 199A deduction does have limits for higher-earning business owners, which means the deduction begins to phase out once your taxable income exceeds certain thresholds.
These thresholds adjust each year for inflation, but generally fall in the range where married couples filing jointly start to phase out around the low-$300,000s and single filers in the mid-$100,000s.
Once your income crosses into this range, the deduction gradually decreases until it disappears entirely at the top of the phase-out zone. This is why tax planning becomes especially important for growing creative businesses. Using tax-saving strategies like shifting income, making retirement contributions, or timing expenses strategically can sometimes save a deduction that would otherwise be lost!
Additionally, whether your business is considered a Specified Service Trade or Business (SSTB) will affect the amount you can deduct for Section 199A. SSTBs include fields like consulting, law, health, financial services, and certain types of performing arts.
In other words, if your creative business involves selling products like candles, art prints, jewelry, or physical goods, you’re typically not an SSTB and can claim the full deduction regardless of income as long as you meet the other requirements.
However, business owners who earn income primarily from their own personal skills or reputation, such as portrait photographers, illustrators, or custom design artists, may be classified as SSTBs. SSTBs still get the Section 199A deduction, but only up to certain income phase-out levels. Above those limits, the deduction disappears entirely.
Which business entity types work with Section 199A?
As we just discussed, all pass-through entity types can work with Section 199A. For sole proprietorships, LLCs, and partnerships, something to keep in mind is that owners of these business entity types will pay self-employment tax on profits. Another note is that the filing and forms work a little different:
Sole Proprietorships and Single-Member LLCs
- There’s no separate business tax return. The business owner reports income on Schedule C of their personal tax return.
Partnerships and Multi-Member LLCs
- The business files Form 1065 to report business income and losses.
- The business prepares a Schedule K-1 for each partner or member.
- Each partner or member uses the information from the Schedule K-1 to report their share of the business’ profits or losses on their individual tax return.
S-Corporations
As for S-Corporations, here’s where things can get interesting because although S-Corporations still qualify for Section 199A, if your business is set up this way, you may also be able to save a significant amount on self-employment taxes (possibly thousands per year!) if your profits are high enough.
The difference here is that S-Corporation owners must pay themselves a reasonable salary, and that salary doesn’t qualify for Section 199A. Instead, only the remaining business profit or distribution qualifies for the deduction.
The tradeoff is that S-Corporations are required to file a separate tax return, Form 1120-S, and will likely need to set up some kind of payroll and bookkeeping.
For these reasons, many smaller creative businesses choose to stay as a sole proprietor or single-member LLC, and that’s perfectly fine! But for many creative businesses, especially ones that are growing quickly, the tax savings can often outweigh the hassle.
Let me give you an example: My client, Alex, is a wedding photographer who earned $120,000 profit as a sole proprietor. If Alex chose to elect S-Corporation status, she could pay herself a reasonable salary of $60,000. In that case, here’s what the numbers would look like:
- $60,000 salary (not eligible for Section 199A deduction)
- $60,000 distribution eligible for Section 199A deduction
- $60,000 x 20% = $12,000 Section 199A deduction
Alex would also save on self-employment tax because the distribution wouldn’t be subject to that tax, so Alex’s example really shows why many successful small businesses eventually elect S-Corporation status.
Which business entity type maximizes the Section 199A deduction?
So if I’ve been explaining this clearly, you hopefully picked up that as long as you have a pass-through entity (so not a C-Corporation), you likely qualify for the Section 199A deduction. Again, the amount of the deduction will phase out if you earn profits over a certain amount or if your business is considered an SSTB.
But what about maximizing the deduction? Here’s a good rule of thumb:
- Under $60,000 profit: A sole proprietorship or single-member LLC is usually best. You’ll still get the Section 199A deduction with minimal paperwork (and without added costs for doing that paperwork correctly).
- Between $60,000 and $120,000 Profit: Consider running the numbers for switching to an S-Corporation. You may save thousands in self-employment taxes while still qualifying to use the Section 199A on your business distributions.
- Over $120,000 Profit: An S-Corporation is probably the most tax-efficient structure for you, but you should still run the calculations with a CPA to make sure your salary is set properly. Hint: Check out my free article about the magic QBI formula to see what I mean!
Abridged by Amy
Section 199A is one of the most valuable tax breaks that’s available to creative entrepreneurs. The great news is that most small businesses qualify for it regardless of their entity type. The key is choosing a structure that balances total tax savings with administrative workload and takes into account how fast your business is growing.
If you want help figuring out which entity makes the most sense for your business, reach out to a CPA who works with small business owners. A single consultation can often save you thousands of dollars per year, and it can also give you the peace of mind that your business is on the right path to achieve financial success.
