The 20 Percent Pass-Through Deduction: A Guide to Section 199A

Figures reflect rules in effect as of October 2026.

If you own a sole proprietorship, a partnership interest or S corporation shares, Section 199A can let you deduct up to 20% of the business’s qualified income from your federal taxable income. The 2025 tax law made the deduction permanent. For 2026, the wage and specified-service limits do not apply up to $201,750 of taxable income, or $403,500 on a joint return.¹˒²˒³

The deduction was written in 2017 to expire after 2025, so for years it was something to use before it was gone. It now stays, with wider income bands and a small minimum.² That makes it worth planning around every year: how you pay yourself, how you hold rental property, and how close your income runs to the thresholds.

How does the deduction work?

Qualified business income, or QBI, is the net profit of a U.S. trade or business you own through a pass-through: a sole proprietorship, a partnership, an S corporation, or certain trusts and estates. It is figured after the deductions that belong to the business, including the deductible half of self-employment tax, self-employed health insurance and retirement plan contributions.⁴

Some income from your business is still left out of QBI:⁵

• Wages, including the reasonable salary an S corporation pays you as an owner-employee.
• Payments a partnership makes to you for your services that do not depend on its profit.
• Investment items such as capital gains, most dividends, and interest not allocable to the business.

The deduction is 20% of QBI, plus 20% of qualified REIT dividends and income from publicly traded partnerships. The total cannot exceed 20% of your taxable income minus net capital gain. You can take it whether you itemize or take the standard deduction.⁵

From 2026 there is also a floor: if you have at least $1,000 of QBI from businesses in which you materially participate, the deduction is at least $400.¹˒³ At the 37% top rate, a full 20% deduction, if the wage and property limit allows it, leaves an effective federal rate of 29.6% on that income.

A worked example for 2026

Here is a hypothetical. A single owner of a sole proprietorship has $150,000 of net profit in 2026, no other income, no retirement contributions or health insurance deduction, and takes the $16,100 standard deduction.³

1. Self-employment tax. It is 15.3% of 92.35% of profit, or $21,194. Half of it, $10,597, is deductible.⁶
2. QBI. Profit less that deduction is $139,403. Twenty percent of it is $27,881.
3. The taxable income limit. Taxable income before the QBI deduction is $139,403 less $16,100, or $123,303. Twenty percent of that is $24,661. It is the lower figure, so the deduction is $24,661.
4. The result. Taxable income falls to $98,642. The deduction comes off income taxed partly at 24% and partly at 22%, so it lowers 2026 federal income tax by about $5,780.³

This owner’s income is well under the threshold, so the type of business and its payroll do not matter. Above the threshold, both do.

What changes above the threshold?

Once taxable income passes the threshold, two limits phase in over the next $75,000 ($150,000 on a joint return) and apply in full above that.¹˒²

Specified service businesses. For a specified service trade or business, the deduction shrinks across the range and is gone above it. The statute defines these by reference to Section 1202. They include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, investment management and trading.¹ Consulting is on the list, so a consulting practice is a specified service business however small its payroll.

Every other business. Above the phase-in range ($276,750 single, $553,500 joint), the deduction for each business is the lesser of:¹

• 20% of its QBI, or
• the greater of 50% of the W-2 wages it pays, or 25% of those wages plus 2.5% of the unadjusted basis of its qualified property.

Unadjusted basis is, broadly, the original cost of depreciable property such as buildings and equipment. Land does not count, because it is not depreciable. Property counts for 10 years after it is placed in service, or for its full depreciation period if that is longer.¹

Can rental real estate qualify?

Rental income counts only if the rental is a trade or business. Revenue Procedure 2019-38 gives a safe harbor: a rental real estate enterprise is treated as a trade or business for 199A if, each year:⁷

• separate books and records are kept for it;
• 250 or more hours of rental services are performed (for an enterprise in existence four years or more, in at least three of the last five years);
• contemporaneous records show the hours, the services, the dates and who performed them; and
• a statement is attached to a timely filed return.

Property you use as a residence, and property under a triple net lease, where the tenant pays the taxes, insurance and maintenance, cannot use the safe harbor. A rental that misses it can still qualify on its own facts as a trade or business.⁵˒⁷

A hypothetical landlord files jointly with 2026 taxable income above $553,500. The rentals produce $300,000 of QBI, pay no wages, and hold buildings with $2 million of unadjusted basis, not counting land. Twenty percent of QBI is $60,000. With no wages, the limit is 2.5% of $2 million, or $50,000. The deduction is the lesser figure: $50,000.

How can owners plan near the thresholds?

Because the deduction depends on taxable income, choices that lower taxable income can keep an owner under a threshold. Each has its own cost, so they are worth weighing together:

• Retirement plan contributions. They lower taxable income, but contributions tied to the business also lower QBI.⁴ My posts on choosing a solo 401(k) or SEP IRA and the mega backdoor Roth in a solo 401(k) cover the plan choices.
• Owner pay in an S corporation. Your salary is not QBI, but it counts as W-2 wages for the wage limit. The trade-offs are in my post on S corporations and self-employment tax.
• Timing. Income or expenses moved across December 31 shift taxable income between years. This matters most for a specified service business inside its phase-in range.
• Rental records. If you rely on the safe harbor, keep the hour logs as you go, not reconstructed in April.

This list is a starting point for a conversation with your CPA, not a plan on its own. The right mix depends on the whole return. I look at it as part of the year-end tax review and the tax-aware planning I do for clients.

What about California?

California does not allow the 199A deduction.⁸ Business income is taxed in full on the state return, at rates up to 13.3% including the 1% tax on taxable income over $1 million.⁹˒¹⁰ Moves that change taxable income affect both returns, but the deduction itself is federal only.

The Bottom Line

Section 199A is now permanent, which makes it a yearly planning item rather than a break to use before it ends. Below the 2026 thresholds, most owners get the full 20%, limited only by taxable income. Above them, the type of business, the wages it pays and the property it holds decide the result. California does not follow it, so the benefit is federal only.

If you own a pass-through business and want to see how the deduction fits your own numbers, book a complimentary 15-minute call.