How W2 Wages Can Increase or Reduce Your Section 199A Deduction

Overview of the QBI Deduction

The Qualified Business Income deduction under Internal Revenue Code Section 199A allows eligible taxpayers to deduct up to 20% of qualified business income from a qualified trade or business. The deduction applies to sole proprietorships, partnerships, S corporations, and certain qualified REIT dividends and publicly traded partnership income.

The deduction was enacted as part of the Tax Cuts and Jobs Act and was made permanent for taxable years beginning in 2026 and later by the One Big Beautiful Bill Act. While the deduction percentage remains unchanged, eligibility and limitation mechanics continue to be governed by taxable income thresholds and wage based limitations.

For a detailed discussion of how Section 199A was made permanent and how the One Big Beautiful Bill Act reshaped long term planning considerations, see my related article Section 199A After OBBBA and the Qualified Business Income Deduction .

(IRC §199A(a); IRC §199A(b); Reg. §1.199A-1)

What Is Qualified Business Income

Qualified business income is the net amount of income, gain, deduction, and loss from a qualified trade or business conducted within the United States. QBI excludes reasonable compensation paid to S corporation shareholders, guaranteed payments to partners, investment income, and income not effectively connected with a United States trade or business.

QBI is determined before applying the Section 199A deduction. Wages paid by the business reduce QBI because they are deductible business expenses, but wages do not eliminate QBI unless income is otherwise excluded under the statute.

(IRC §199A(c); Reg. §1.199A-3)

Taxable Income Thresholds and Their Significance

The relationship between the QBI deduction and wages paid depends on the taxpayer taxable income, not on QBI. Section 199A establishes threshold amounts that are indexed annually for inflation.

For illustration purposes, the following examples assume 2025 indexed thresholds:

• Married filing jointly: threshold approximately $364,200 with a $100,000 phaseout range
• Single or head of household: threshold approximately $182,100 with a $50,000 phaseout range

(IRC §199A(b)(3); Reg. §1.199A-1(d))

Below the Threshold: No Wage Limitation Applies

When taxable income is at or below the threshold, the deduction is generally equal to 20% of QBI. W2 wages and qualified property are not relevant.

Example 1: Married Filing Jointly Below Threshold

• Taxable income: $300,000
• Business type: Non SSTB
• QBI: $200,000
• W2 wages: $20,000

Deduction: 20% × $200,000 = $40,000

W2 wages do not affect the calculation.

Example 2: Single Filer Below Threshold

• Taxable income: $160,000
• Business type: SSTB
• QBI: $120,000
• W2 wages: $0

Deduction: 20% × $120,000 = $24,000

SSTB status does not matter below the threshold.

Within the Phaseout Range: Partial Wage Limitation

Once taxable income exceeds the threshold, the W2 wage limitation begins to apply for non specified service trades or businesses. For specified service trades or businesses, QBI and the deduction begin to phase out proportionately.

Example 3: Married Filing Jointly in Phaseout Range Non SSTB

• Taxable income: $400,000
• QBI: $300,000
• W2 wages: $80,000
• UBIA: $0

Tentative deduction: 20% × $300,000 = $60,000

Wage limitation: 50% × $80,000 = $40,000

Because the taxpayer is in the phaseout range, the deduction is partially reduced and limited. The final deduction is less than $60,000 and greater than $40,000 based on the statutory reduction formula.

(IRC §199A(b)(3); Reg. §1.199A-1(d)(2))

Above the Phaseout Ceiling: Full Wage Limitation for Non SSTBs

For non specified service trades or businesses, once taxable income exceeds the top of the phaseout range, the W2 wage limitation fully applies.

The deduction is limited to the greater of:

• 50% of W2 wages
• 25% of W2 wages plus 2.5% of the unadjusted basis immediately after acquisition of qualified property

(IRC §199A(b)(2); Reg. §1.199A-2)

Example 4: Married Filing Jointly Above Phaseout Non SSTB

• Taxable income: $520,000
• QBI: $400,000
• W2 wages: $120,000
• UBIA: $0

Tentative deduction: 20% × $400,000 = $80,000

Wage limitation: 50% × $120,000 = $60,000

Allowed deduction: $60,000

QBI is not reduced by the limitation. Only the deduction is capped.

Example 5: Single Filer Above Phaseout Non SSTB

• Taxable income: $260,000
• QBI: $180,000
• W2 wages: $30,000

Tentative deduction: 20% × $180,000 = $36,000

Wage limitation: 50% × $30,000 = $15,000

Allowed deduction: $15,000

Effect on Specified Service Trades or Businesses

Specified service trades or businesses are subject to an additional statutory rule. Once taxable income exceeds the top of the phaseout range, all QBI from an SSTB is treated as zero.

When QBI is reduced to zero, no deduction is available and the wage limitation does not apply.

(IRC §199A(d)(3); Reg. §1.199A-5)

Example 6: Married Filing Jointly Above Phaseout SSTB

• Taxable income: $520,000
• Business type: SSTB
• QBI before limitation: $400,000
• W2 wages: $150,000

QBI deemed $0

Allowed deduction: $0

W2 wages do not restore eligibility.

Distinguishing QBI From the Deduction Limitation

A common misconception is that QBI itself is limited by wages paid. This is incorrect.

QBI is determined independently based on business income and expenses. Wages affect QBI only because they are deductible expenses. The W2 wage limitation applies solely to the amount of the Section 199A deduction, not to the amount of QBI generated.

(IRC §199A(a); Reg. §1.199A-1)

Practical Planning Considerations

For non specified service trades or businesses above the threshold, paying W2 wages can increase the allowable deduction, but doing so also reduces QBI and increases payroll tax exposure. The net benefit must be evaluated annually.

For S corporations, reasonable compensation paid to shareholders counts as W2 wages but reduces QBI dollar for dollar. For partnerships, guaranteed payments do not increase W2 wages and do not help satisfy the limitation.

Because Section 199A is now permanent, compensation and hiring decisions should be evaluated as long term structural planning rather than temporary tax strategies.

(IRC §199A; Reg. §1.199A-2; Reg. §1.199A-3)

Summary

The Section 199A deduction provides a significant benefit, but its availability and size depend on taxable income levels and, for many taxpayers, on wages paid by the business. For non specified service trades or businesses above the income threshold, wages do not limit QBI itself, but they do limit how much of that income may be deducted. Numerical examples by filing status highlight why understanding these mechanics is essential for accurate tax planning and compliance.