The 23% QBI Deduction Explained: What the Small Business Tax Cut Act Could Mean for Your Pass-Through Income

You built your business as a pass-through — an S corporation, LLC, partnership, or sole proprietorship — precisely because you didn't want to pay tax twice. Yet every April you watch C corporation owners talk about their 21% flat rate while your profits flow straight to your personal return and get taxed at up to 37%. Section 199A was supposed to close that gap. Now Congress is debating whether to widen it further, from 20% to 23%.

If you earn qualified business income, that three-percentage-point bump is not a rounding error. On $100,000 of QBI, it is an extra $3,000 you never pay tax on — and at a 24% marginal rate, that is $720 back in your pocket. On $250,000, it is $7,500 of additional deduction, worth $1,800 or more depending on your bracket. The proposal behind those numbers — H.R. 8415, the Small Business Tax Cut Act — has already picked up support from one of the country's largest small-business groups. Whether it becomes law or not, understanding how it works will make you a sharper tax planner in 2026.

What Section 199A Actually Does​

Before 2018, pass-through owners had a structural disadvantage. A C corporation paid 21% at the entity level and then shareholders paid again on dividends. A sole proprietor, partner, or S corporation shareholder paid once, but at individual rates that climbed to 37%. To give pass-throughs a comparable break, the Tax Cuts and Jobs Act created Section 199A: the Qualified Business Income (QBI) deduction.

Here is the plain-English version:

• Who qualifies: Owners of sole proprietorships, partnerships, S corporations, and some trusts and estates. C corporations do not.
• What counts as QBI: Net income from a qualified trade or business operating in the United States. It excludes wages you pay yourself as an S corporation shareholder, guaranteed payments, capital gains, dividends, and interest income not tied to the business.
• How big is it: Up to 20% of your QBI, plus 20% of qualified REIT dividends and publicly traded partnership income. It is a deduction from taxable income, not a credit — it reduces the income you are taxed on, and you can claim it whether you itemize or take the standard deduction.
• Where it shows up: On Form 8995 (simplified) or Form 8995-A (if you are above the income thresholds), flowing to line 13 of Form 1040.

The intuition is simple. If your business earns $80,000 of QBI and you qualify for the full 20%, you deduct $16,000. You are taxed as if you earned $64,000 of business income. At a 22% marginal rate, that deduction saves you $3,520.

The 2026 Baseline: Permanent at 20% — With New Tweaks​

The QBI deduction was originally scheduled to expire after December 31, 2025. The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025 as Public Law 119-21, made it permanent. That alone removed the biggest planning uncertainty small businesses faced.

It also made three taxpayer-friendly changes effective for tax years beginning after December 31, 2025:

1. Wider phase-in ranges. The old thresholds were $50,000 for single filers and $100,000 for joint filers. For 2026, they rise to $75,000 for single filers and $150,000 for joint filers, with inflation adjustments after 2026. This is the window where limitations phase in gradually instead of hitting all at once.

2. A $400 minimum deduction. If you have at least $1,000 of active QBI — meaning income from a business where you materially participate — you get at least a $400 deduction, even if the normal wage and property calculations would otherwise give you zero. For very small, low-wage businesses, this matters.

3. Inflation indexing continues. The taxable income thresholds that trigger the W-2 wage and SSTB limits — roughly $197,300 single / $394,600 joint for 2025, before the new phase-in window starts — remain indexed for inflation. For 2026, expect those top-of-phase-in numbers to be somewhat higher.

Crucially, OBBBA kept the rate at 20%. The House's initial draft would have raised it to 23%, but the final law did not. That is where H.R. 8415 comes in.

What H.R. 8415 Would Change​

Introduced by Representative David Kustoff and endorsed by the National Federation of Independent Business (NFIB), the Small Business Tax Cut Act is short — just a few lines — but its effect is significant. It would amend subsections (a)(2), (b)(1)(B), and (b)(2)(A) of Section 199A by striking "20 percent" and inserting "23 percent" everywhere it appears.

In practice, that means:

• The headline QBI deduction rises from 20% to 23% of qualified business income.
• The companion deductions for qualified REIT dividends and qualified publicly traded partnership income also rise to 23%.
• The bill's sponsors describe an additional goal of expanding eligibility, though the legislative text as introduced focuses on the rate increase. The NFIB letter of support frames the whole package as providing tax relief to tens of millions of small businesses.

The bill has not been enacted. As of mid-2026, it sits as a proposal that builds on the momentum of making the deduction permanent. But even as a proposal, it tells you where the political wind is blowing: toward a larger, not smaller, pass-through break.

How Much Is an Extra 3% Worth to You?​

The value of any deduction equals deduction amount times your marginal tax rate. Because the QBI deduction is claimed on your individual return, your bracket matters.

A few takeaways:

• The benefit scales linearly. Double your QBI, double the benefit.
• Higher brackets benefit more in dollars, but every bracket benefits proportionally. Even at 12%, an extra $3,000 of deduction on $100,000 of QBI saves $360 — real money for a small operation.
• State taxes amplify the effect if your state conforms to the federal QBI deduction. Many do, some do not. Check your state — the federal change alone does not guarantee a state benefit.

Think about what that extra deduction covers in business terms. $660 to $960 on $100,000 of QBI pays for a year of accounting software and a professional tax review. $2,400 on $250,000 covers health insurance premiums for a month or a meaningful equipment upgrade.

The Limits That Still Apply — And Why the Wider Phase-In Matters​

The QBI deduction is not unlimited. Two sets of rules reduce or eliminate it at higher incomes. Understanding them is essential whether the rate is 20% or 23%, because the proposed increase does not remove these guardrails.

1. The W-2 Wage and Qualified Property Limitation​

Once your taxable income exceeds the threshold amount, your deduction cannot exceed the greater of:

• 50% of the W-2 wages paid by the business, or
• 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property

Qualified property means tangible, depreciable property — think machinery, equipment, buildings — that you still hold and use in the business, measured before depreciation has eroded its basis.

Example: You are a single filer with taxable income above the full phase-in range. Your S corporation has $200,000 of QBI, pays $60,000 in W-2 wages, and holds $400,000 of qualified property.

• 20% of QBI = $40,000
• 50% of wages = $30,000
• 25% of wages + 2.5% of UBIA = $15,000 + $10,000 = $25,000
• Your deduction is capped at $30,000 (the greater of the two wage tests), not $40,000 — unless the new $75,000/$150,000 phase-in window softens the blow.

The wider phase-in window from OBBBA means more taxpayers stay under or partially within the limits. If your taxable income is $260,000 married filing jointly, you previously would have been deep into the limitation. With the window starting at $150,000 above the threshold instead of $100,000, you phase in more slowly and keep a larger fraction of the deduction.

Whether the rate is 20% or 23%, the same formula applies — just with 23% of QBI as the starting point under H.R. 8415.

2. The Specified Service Trade or Business (SSTB) Rule​

If your business is an SSTB — health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, or any business where the principal asset is the reputation or skill of one or more owners — a second limitation kicks in.

• Below the threshold: SSTB status does not matter. You get the full deduction.
• Within the phase-in range: Your QBI, wages, and UBIA from the SSTB are partially excluded. The exclusion phases in proportionally across the window.
• Above the phase-in range: No QBI, wages, or UBIA from the SSTB counts at all. Your deduction for that business is zero.

The wider $75,000/$150,000 windows help SSTB owners too. More income fits inside the partial-allowance zone before the cliff to zero. A freelance consultant with $280,000 of taxable income (single) who would have been fully phased out under the old $50,000 window may now still qualify for a partial deduction.

The bill to raise the rate to 23% does not change SSTB definitions. If you are an SSTB owner, the rate increase helps you only to the extent you are still within or below the phase-in range.

What the $400 Minimum Means in Practice​

The new $400 floor is aimed at active owners of small, low-wage businesses — the sole proprietor with no employees, the partnership with modest QBI that fails the wage test.

Suppose you run a solo consulting practice with $15,000 of QBI, no employees, and no qualified property. Under the old math, your W-2 wage limitation would be zero, so your deduction would be zero. Under OBBBA, if you materially participate and have at least $1,000 of QBI, you get at least $400. At 23%, that floor would presumably rise proportionally, though the bill text as introduced focuses on the percentage change. Even at $400, it is a nod to the smallest businesses that the wage tests otherwise shut out entirely.

How to Prepare Your Books Either Way​

The deduction may stay at 20% or rise to 23%. Your job is the same: make your QBI easy to compute and defend. The IRS ties the deduction to what your books show, and sloppy records are the fastest way to lose it.

Track QBI Separately From Everything Else​

QBI is not the same as revenue, profit, or taxable income. Create a clean trail:

• Separate qualified income from excluded income. Capital gains, dividends, interest, and foreign income are not QBI. If your business holds investments alongside operations, keep them in separate accounts.
• Document W-2 wages by business. If you own multiple entities, do not commingle payroll. The wage limitation is tested per business unless you make a formal aggregation election under Regulation 1.199A-4. That election requires common ownership, same tax year, and that none of the businesses is an SSTB.
• Maintain a qualified property register. For each asset, record the unadjusted basis immediately after acquisition, the placed-in-service date, and the depreciable period. You need 10 years or the last year of the asset's recovery period, whichever is longer, to know whether it still counts toward UBIA.
• Separate SSTB and non-SSTB activities. If you run a medical practice that also sells skincare products, those may be different trades or businesses with different SSTB treatment. Keep distinct profit and loss statements.

Reconcile Quarterly, Not Just at Year-End​

QBI planning is sensitive to taxable income, which means timing matters. A large equipment purchase, a retirement contribution, or accelerating income can push you across a threshold. If you only look in March when your CPA asks, you have lost the ability to act.

A simple quarterly routine covers it:

1. Update profit and loss for each entity.
2. Project full-year taxable income before and after the QBI deduction.
3. Check where you sit relative to the phase-in thresholds ($75,000 single / $150,000 joint phase-in windows for 2026, on top of the base thresholds).
4. Model the wage and UBIA tests at 20% and at 23% so you know how much a rate change would be worth.

When you model both rates, you can answer the question your tax advisor will ask: "Is it worth restructuring payroll or buying that equipment before year-end to maximize the deduction if the rate goes to 23%?"

Common Mistakes That Shrink the Deduction​

• Paying unreasonably low W-2 wages from your S corporation. The IRS requires reasonable compensation. Cutting your salary to inflate QBI can backfire twice: the IRS can recharacterize distributions as wages, and you lower the wage base that supports your deduction above the thresholds.
• Treating guaranteed payments as QBI. They are explicitly excluded under Section 199A(c)(4)(B). If you are a partner, work with your accountant to structure compensation so you understand what counts.
• Forgetting that the deduction is claimed at the individual level. Your business does not take it. You do, on Form 8995 or 8995-A. That means your overall taxable income — including spouse income, investment income, and other sources — determines your limits, not just business profit.
• Assuming state conformity. About half the states conform to Section 199A; others decouple. An extra 3% federally does not automatically change your state return.

If the Rate Stays at 20% vs. Rises to 23%​

Here is a practical way to think about the two scenarios:

• If it stays at 20%: Nothing is lost. The permanent 20% deduction plus the wider phase-in and $400 minimum already make 2026 more favorable than 2025 for many owners. Your existing planning — wage levels, property investments, SSTB analysis — still works.
• If it rises to 23%: The same planning delivers a 15% larger deduction (3 divided by 20). Strategies that were marginally worth doing at 20% — like increasing W-2 wages to lift the wage cap, or accelerating qualified property purchases — may cross into clearly worthwhile territory.

In both cases, the highest-return move is not guessing the legislative outcome but building books that let your advisor run the numbers instantly when the outcome is known.

The Bigger Picture: Why This Debate Signals Opportunity​

The fight over 20% versus 23% is a proxy for a larger question: should the tax code permanently favor pass-through investment at roughly the same level as C corporation investment? The rate cut for C corporations to 21% was permanent from the start. Pass-through relief was temporary until OBBBA made it permanent. Raising it to 23% would push the effective top rate on pass-through income from about 29.6% (37% × 80%) down to about 28.5% (37% × 77%), slightly closer to the combined C corporation rate after dividends.

For you, the signal matters more than the precise effective rate. Congress made the deduction permanent because millions of small businesses organized as pass-throughs and told lawmakers the break matters for hiring, wages, and equipment. Whether the final number is 20% or 23%, lawmakers have affirmed that the deduction is not going away. That stability lets you invest, hire, and plan with one fewer sunset clause on the calendar.

Keep Your QBI Records Audit-Ready​

A larger deduction is only as good as the records behind it. The IRS instructions for Forms 8995 and 8995-A ask for QBI, W-2 wages, and UBIA per business, and examinations routinely request payroll reports, fixed-asset schedules, and profit and loss details that tie back to the return. If those records live in a spreadsheet you update once a year, you are one information request away from a scramble.

This is where plain-text accounting earns its keep: every transaction is version-controlled, every number is traceable to its source, and your QBI, wage, and property totals are not hidden inside a proprietary database.

Simplify Your Financial Management​

Whether the QBI deduction stays at 20% or rises to 23%, keeping clear, defensible books is what turns a line in the tax code into real savings. Beancount.io gives you plain-text accounting that is transparent, version-controlled, and AI-ready — so you can reconcile W-2 wages, track qualified property, and project your deduction with confidence, not guesswork. Get started for free and see why developers and finance professionals are switching to plain-text accounting.