The QBI Deduction Explained: Section 199A for Milpitas Small Business Owners

If you own a small business organized as a sole proprietorship, partnership, S-corporation, or LLC, you may be eligible for one of the most significant tax deductions available to small business owners — the Qualified Business Income (QBI) deduction under Section 199A. Introduced by the Tax Cuts and Jobs Act of 2017 and scheduled to expire after 2025 (before being extended under the One Big Beautiful Bill), this deduction can reduce your taxable income by up to 20% of your net business earnings.

For a restaurant owner in Milpitas netting $150,000 from their business, a 20% QBI deduction means $30,000 less in taxable income — a federal tax savings of roughly $6,600 in the 22% bracket. For higher earners, the math gets more complex, but the potential savings are even larger. Here is what every Bay Area small business owner needs to understand.

Who Qualifies for the QBI Deduction

The deduction is available to individuals, trusts, and estates that receive income from a "pass-through" business — one where business income passes through to the owner's personal tax return rather than being taxed at the entity level. Qualifying business structures include:

• Sole proprietorships (Schedule C filers)
• Single-member LLCs treated as disregarded entities
• Partnerships (the partner's share of business income)
• S-corporations (the shareholder's share of business income)
• Qualified real estate investment trusts (REITs)
• Publicly traded partnerships (PTPs)

C-corporations and their shareholders do not receive the QBI deduction — C-corps pay their own corporate income tax and are not pass-throughs.

The Basic Calculation

For most small businesses with income below the threshold (more on that below), the deduction is straightforward: 20% of your qualified business income, subject to an overall cap of 20% of your taxable income minus net capital gains.

Income Thresholds and Phase-Outs

Above certain taxable income levels (adjusted annually for inflation), the deduction becomes more complicated. For 2025:

• Below the threshold (~$197,300 single / ~$394,600 married filing jointly): Take 20% of QBI with no additional limitations. Most small business owners in this range qualify for the full deduction with no complications.
• Above the threshold: Two additional limitations begin to phase in — a W-2 wage limitation and a "Specified Service Trade or Business" (SSTB) exclusion.

W-2 Wage Limitation

Above the income threshold, your deduction is limited to the greater of: (a) 50% of the W-2 wages paid by the business, or (b) 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property. Businesses with employees — even just one or two — typically have enough W-2 wages to avoid this limitation. Sole proprietors with no employees (who pay themselves no W-2 wages) may find their deduction substantially reduced above the threshold.

Specified Service Trades or Businesses (SSTBs)

The most significant limitation: if your business is an SSTB, the deduction phases out entirely once income exceeds the threshold by $100,000 (married) or $50,000 (single). SSTBs include:

• Health (physicians, dentists, therapists)
• Law and legal services
• Accounting and tax preparation (note: this applies to my own profession)
• Financial services and investing
• Consulting where the principal asset is the reputation or skill of the owner
• Performing arts and athletics

Notably excluded from the SSTB list: engineering, architecture, and real estate rental activities (which have their own treatment). A restaurant, retail shop, auto repair business, construction company, or software product company is not an SSTB and qualifies fully.

The OBBB: Rate Increase to 23%

The One Big Beautiful Bill proposes increasing the QBI deduction rate from 20% to 23% — a meaningful improvement for qualifying business owners. If enacted, a business owner with $150,000 in QBI would see their deduction increase from $30,000 to $34,500, an additional $990 in federal tax savings at the 22% bracket. For higher earners the benefit scales proportionally.

The OBBB also proposes making the QBI deduction permanent (rather than sunsetting in 2025 as originally scheduled). Both the rate increase and permanence are pending final legislation.

California Does Not Allow the QBI Deduction

California has not conformed to Section 199A and does not allow any equivalent deduction at the state level. Your full business income is taxable in California at ordinary income rates, regardless of your federal QBI deduction.

For Bay Area business owners in California's higher brackets, this means your effective state tax burden is higher than comparable business owners in most other states — even if you are maximizing the federal deduction. Understanding both federal and California tax simultaneously is essential to accurate tax planning.

How to Maximize Your QBI Deduction

1. Ensure your entity structure is a pass-through. If you are operating as a C-corp and don't need to be, converting or restructuring may make you eligible. There are many non-tax reasons to use a C-corp (investor expectations, QSBS eligibility), so weigh them carefully.
2. Review your W-2 wage payments if above the income threshold. S-corp owners who take reasonable compensation as W-2 wages also create W-2 wages for the QBI calculation — reasonable compensation planning interacts directly with the deduction.
3. Separate SSTB and non-SSTB activities if your business spans both. A consulting firm that also sells software products may be able to separate the qualifying non-SSTB income for a partial deduction.
4. Consider income timing. If your income fluctuates year to year, years when income is below the threshold allow the full deduction without W-2 wage limitations — planning around that can matter.
5. Don't overlook aggregation rules. If you own multiple pass-through businesses, you may be able to aggregate them for QBI purposes, combining their W-2 wages and property to satisfy the limitation — this can unlock a larger deduction than treating each business separately.