This article outlines significant changes proposed affecting the deduction for qualified business income under Internal Revenue Code (IRC) Section 199A in the provisions of The One, Big, Beautiful Bill that were approved in the Ways and Means Committee on the morning of May 14. These modifications, particularly the structural changes to the taxable income limitations and the increase in the deduction rate, warrant careful review for taxpayers engaged in qualified trades or businesses.

The proposed legislation, titled "Subtitle A—Make American Families and Workers Thrive Again," addresses various tax provisions, including permanent extensions and temporary enhancements. Specifically, Section 110005 of this subtitle focuses on the deduction for qualified business income.

Here are the key modifications to the Section 199A deduction:

Permanent Extension: The deduction for qualified business income, including the deduction for qualified Real Estate Investment Trust (REIT) dividends and qualified publicly traded partnership income, is made permanent. This is achieved by striking subsection (i) of Section 199A. Previously, the deduction was set to expire for taxable years beginning after December 31, 2025 [See IRC Sec. 199A(i) prior law].
Increase in Deduction Percentage: The percentage used to calculate the deduction is increased from 20 percent to 23 percent. This increase applies in three specific contexts within Section 199A:
- Section 199A(a)(2): The percentage of the taxpayer's qualified business income (QBI) from each qualified trade or business.
- Section 199A(b)(1)(B): The percentage of the excess of the taxpayer's taxable income over net capital gain used in determining the maximum allowable deduction.
- Section 199A(b)(2)(A): The percentage of the aggregate amount of the taxpayer's qualified REIT dividends and qualified publicly traded partnership income.
Modification of Taxable Income Limitations: For taxpayers whose taxable income exceeds the threshold amount, the existing phase-in rules based on W-2 wages, qualified property, and the exclusion for specified service trades or businesses (SSTBs) are replaced with a new two-step process.
- Step 1: For each qualified trade or business, the deductible amount (23 percent of QBI) is limited to the greater of the W-2 wages attributable to the qualified trade or business or the sum of the W-2 wages and 25 percent of the unadjusted basis immediately after acquisition (UBIA) of qualified property. This step, unlike prior law, does not have a phase-in range. The taxpayer then aggregates these limited amounts from all qualified trades or businesses. As the definition of qualified trade or business found at IRC 199A(d)(1)(A) does not include SSTBs, those businesses would end up with zero for the computed allowed amount.
- Step 2: The taxpayer calculates 23 percent of the qualified business income from all trades or businesses, including SSTBs, without regard to the W-2 wage and qualified property limitation. This amount is then reduced by a "limitation phase-in amount" equal to 75 percent of the excess of the taxpayer's taxable income over the threshold amount.
- The taxpayer's combined qualified business income amount for the year is the greater of the aggregate deductible amounts determined under Step 1 and Step 2. Section 199A(b)(3) is amended to reflect this new calculation. As a conforming amendment, Section 199A(d)(3), which previously detailed the SSTB phase-out based on taxable income, is struck.
Inflation Adjustment for Threshold Amounts: The threshold amounts used for the modified taxable income limitations (as described in the new two-step process) will be indexed for inflation for taxable years beginning after 2025.
Inclusion of Qualified BDC Interest Dividends: The deduction for qualified business income is expanded to include certain interest dividends from qualified business development companies (BDCs). This is accomplished by inserting ", qualified BDC interest dividends," after "qualified REIT dividends" in Sections 199A(b)(1)(B) and 199A(c)(1).
Exclusion Related to Qualified Tips: Note that Section 199A(c)(4) is amended to exclude amounts for which a deduction is allowed under new Section 224 (relating to qualified tips) from the definition of qualified business income.

Effective Dates:

The amendments related to the permanent extension of Section 199A, the increase in the deduction percentage to 23%, the modification of the taxable income limitations (the new two-step rule), the inflation adjustment for threshold amounts, and the inclusion of qualified BDC interest dividends would be applicable to taxable years beginning after December 31, 2025.

The amendment to Section 199A(c)(4) excluding amounts related to the qualified tips deduction (new Section 224) from qualified business income would apply to taxable years beginning after December 31, 2024.

These proposed changes represent a significant restructuring and enhancement of the Section 199A deduction, particularly for higher-income taxpayers and those with SSTBs, warranting careful planning and analysis for taxable years beginning in 2025 and 2026.

Prepared with assistance from NotebookLM.