Adjustments and Deductions
Overview of Adjustments to Gross Income (Above-the-Line Deductions)
Adjustments to gross income — also called above-the-line deductions — are subtracted from total income to arrive at Adjusted Gross Income (AGI). Unlike itemized deductions, these adjustments are available whether or not the taxpayer itemizes.
| Adjustment | IRC Section | Key Limit |
|---|---|---|
| Educator expenses | §62(a)(2)(D) | $300 |
| Student loan interest | §221 | $2,500 |
| HSA contributions | §223 | $4,300 / $8,550 (2025) |
| Moving expenses (military only) | §217 | Actual expenses |
| Penalty on early withdrawal of savings | §62(a)(9) | Amount forfeited |
| Alimony (pre-2019 agreements only) | §215 | Per agreement |
| Attorney fees (certain cases) | §62(a)(20)-(21) | Amount of fees |
| IRA contributions | §219 | $7,000 (2025) |
| One-half of self-employment tax | §164(f) | 50% of SE tax |
| Self-employed health insurance | §162(l) | 100% of premiums |
| Self-employed retirement plans | §404 | Per plan limits |
The distinction matters because AGI serves as the benchmark for many other tax calculations — the 7.5% medical expense floor, the SALT cap, charitable contribution limits, and phase-outs for credits and deductions all reference AGI.
Educator Expenses
A qualifying K–12 educator may deduct up to $300 (2025) for unreimbursed expenses paid for books, supplies, computer equipment, and supplementary materials used in the classroom.
- Who qualifies: Teachers, instructors, counselors, principals, and aides who work at least 900 hours during the school year in a K–12 school.
- Married educators: If both spouses are eligible educators filing jointly, each may claim up to $300 (total $600).
- The deduction is taken as an adjustment to income — no need to itemize.
Example
Sarah teaches 5th grade and spends $475 on classroom supplies in 2025. She deducts $300 as an adjustment to income. The remaining $175 is not deductible (the old miscellaneous itemized deduction for unreimbursed employee expenses was eliminated by the TCJA).
Student Loan Interest
A taxpayer may deduct up to $2,500 of interest paid on qualified education loans as an adjustment to income.
- The loan must have been taken out solely to pay qualified higher education expenses.
- The deduction is phased out at higher income levels (MAGI-based phase-out; the range is adjusted annually for inflation).
- Not available to taxpayers who are claimed as a dependent on another return or who file as Married Filing Separately.
Example
Marcus graduated from college with $45,000 in federal student loans. In 2025, he pays $3,200 of interest. His MAGI is below the phase-out threshold. Marcus deducts $2,500 (the maximum) as an adjustment to income.
Health Savings Accounts (HSAs)
A taxpayer enrolled in a high-deductible health plan (HDHP) and covered by no other non-HDHP health insurance may contribute to a Health Savings Account and deduct the contribution as an adjustment to income.
2025 Contribution Limits
| Coverage | Annual Limit | Minimum Deductible | Max Out-of-Pocket |
|---|---|---|---|
| Self-only | $4,300 | $1,650 | $8,300 |
| Family | $8,550 | $3,300 | $16,600 |
- Catch-up contribution: Taxpayers age 55 or older may contribute an additional $1,000.
- Contributions by an employer are excluded from gross income (not deducted).
- Distributions used for qualified medical expenses are tax-free.
Distributions used for non-medical purposes before age 65 are included in gross income and subject to a 20% penalty. After age 65, non-medical distributions are included in income but the penalty does not apply.
Example
Jamie (age 42, self-only HDHP coverage) contributes $4,300 to an HSA in 2025. The full $4,300 is deductible as an adjustment to income. During the year, Jamie withdraws $1,200 to pay for a dental procedure — that withdrawal is tax-free. If Jamie had withdrawn $800 to pay for a vacation, the $800 would be taxable income plus a $160 penalty (20%).
Moving Expenses
Under the TCJA, the moving expense deduction is suspended for all taxpayers except active-duty members of the Armed Forces who move pursuant to a military order.
- The move must be incident to a permanent change of station.
- Deductible expenses include reasonable costs of moving household goods and travel (including lodging) from the old to the new residence.
- Meals during the move are not deductible.
Alimony
The deductibility of alimony depends entirely on when the divorce or separation agreement was executed.
| Agreement Date | Payor Treatment | Payee Treatment |
|---|---|---|
| Before January 1, 2019 | Deductible (adjustment to income) | Included in gross income |
| On or after January 1, 2019 | Not deductible | Not included in gross income |
Requirements for Pre-2019 Alimony to Be Deductible
- Payment must be in cash (or check)
- Payment must be made under a written divorce or separation instrument
- The instrument must not designate the payment as non-alimony
- Spouses may not be members of the same household at the time of payment
- Payments must cease upon the death of the payee
- The payment must not be treated as child support or a property settlement
Child support is never deductible by the payor and never taxable to the payee, regardless of when the agreement was executed. If payments are reduced upon a child-related contingency (e.g., the child turning 18), the reduction is treated as child support.
Example
Derek pays $2,000/month to his ex-spouse under a divorce decree entered in 2017. Of this, $800 is designated as child support. Derek deducts $1,200/month ($14,400/year) as alimony. The $800/month child support is not deductible. If the decree had been entered in 2020, none of the $2,000/month would be deductible.
IRA Contributions
Individuals may contribute to an Individual Retirement Account (IRA). Three main types exist:
| Type | Contributions | Tax Treatment of Contributions | Distributions |
|---|---|---|---|
| Traditional (Deductible) | Pre-tax | Deductible as adjustment to income | Taxed as ordinary income |
| Traditional (Nondeductible) | After-tax | Not deductible | Only earnings taxed |
| Roth | After-tax | Not deductible | Tax-free if qualified |
Contribution Limits (2025)
| Limit | Amount |
|---|---|
| Annual contribution (under age 50) | $7,000 |
| Catch-up contribution (age 50+) | $1,000 additional |
| Maximum (age 50+) | $8,000 |
- The contribution limit is per individual, not per account.
- A nonworking spouse may contribute up to $7,000 to a spousal IRA if the couple files jointly and the working spouse has sufficient earned income.
Traditional IRA Deductibility Phase-Out
If the taxpayer (or spouse) is an active participant in an employer-sponsored retirement plan, the deductible amount of a traditional IRA contribution is phased out based on MAGI. The phase-out ranges are adjusted annually.
If neither spouse is covered by an employer plan, the full traditional IRA contribution is deductible regardless of income level.
Roth IRA Income Limits
Roth IRA contributions are phased out at higher MAGI levels. Taxpayers whose income exceeds the phase-out range cannot contribute directly to a Roth IRA (though a backdoor Roth conversion may be available).
Example
Priya (age 35) earns $70,000 and is covered by her employer's 401(k). She contributes $7,000 to a traditional IRA. Because she is an active participant in an employer plan, her deduction may be reduced or eliminated depending on whether her MAGI falls within the phase-out range. If her MAGI is below the phase-out floor, the full $7,000 is deductible.
Self-Employed Adjustments
Self-employed individuals are entitled to several above-the-line deductions that mirror benefits available to employees of corporations.
One-Half of Self-Employment Tax
As computed on Schedule SE, the taxpayer deducts 50% of self-employment tax as an adjustment to income. See the Other Individual Taxes chapter for the full SE tax computation.
Self-Employed Health Insurance
A self-employed individual may deduct 100% of health insurance premiums paid for the taxpayer, spouse, and dependents as an adjustment to income.
- The deduction cannot exceed the taxpayer's net self-employment income from the business under which the plan is established.
- The taxpayer (or spouse) must not be eligible for employer-subsidized health coverage.
Self-Employed Retirement Plans
Self-employed individuals may deduct contributions to qualified retirement plans:
| Plan Type | 2025 Contribution Limit |
|---|---|
| SEP-IRA | 25% of net SE earnings (after SE tax deduction), up to $70,000 |
| SIMPLE IRA | $16,500 employee deferral + employer match or contribution |
| Solo 401(k) | $23,500 employee deferral + employer contribution (total up to $70,000) |
Example
Jamie (age 40) has $150,000 of net self-employment income. After the deduction for half of SE tax, net SE earnings are approximately $139,000. Jamie contributes to a SEP-IRA:
Jamie deducts $34,750 as an adjustment to income.
Standard Deduction
After computing AGI, a taxpayer claims either the standard deduction or itemized deductions — whichever is greater.
2025 Standard Deduction Amounts
| Filing Status | Standard Deduction |
|---|---|
| Single | $15,000 |
| Married Filing Jointly | $30,000 |
| Married Filing Separately | $15,000 |
| Head of Household | $22,500 |
| Qualifying Surviving Spouse | $30,000 |
Additional Standard Deduction
Taxpayers who are age 65 or older or blind receive an additional standard deduction amount:
| Status | Additional Amount (2025 Approx.) |
|---|---|
| Unmarried (Single or HoH) — per qualifying condition | $2,000 |
| Married (MFJ or MFS) — per qualifying condition | $1,600 |
A married taxpayer who is both 65+ and blind receives two additional amounts ($3,200 total).
Certain taxpayers cannot claim the standard deduction:
- Married Filing Separately if the other spouse itemizes
- Nonresident aliens
- Individuals filing a return for a short tax year due to a change in accounting period
Itemized Deductions
The following sections cover the major categories of itemized deductions reported on Schedule A.
Medical and Dental Expenses
A taxpayer may deduct unreimbursed medical and dental expenses paid for the taxpayer, spouse, and dependents during the tax year, but only to the extent total expenses exceed 7.5% of AGI.
What Qualifies
- Payments to doctors, dentists, surgeons, and other medical practitioners
- Hospital and nursing home fees
- Prescription drugs and insulin
- Medical insurance premiums (not pre-tax employer premiums)
- Transportation for medical care
- Long-term care expenses (subject to age-based limits on insurance premiums)
What Does NOT Qualify
- Cosmetic surgery (unless necessary to correct a deformity from disease, accident, or congenital abnormality)
- Over-the-counter medications (other than insulin)
- General health club or gym memberships
- Funeral expenses
Timing
Medical expenses are deducted in the year paid (cash basis), regardless of when the services were rendered.
Example
Priya has AGI of $80,000 and pays $9,500 in unreimbursed medical expenses during 2025.
Priya deducts $3,500 on Schedule A.
State, Local, and Foreign Taxes (SALT)
Taxpayers may deduct certain state and local taxes paid during the year, subject to a $10,000 cap ($5,000 for MFS) under the TCJA.
Deductible Taxes
| Tax | Deductible? |
|---|---|
| State and local income taxes | Yes (or sales tax — choose one) |
| State and local sales taxes | Yes (if elected instead of income tax) |
| State and local real estate taxes | Yes |
| State and local personal property taxes (ad valorem) | Yes |
| Foreign income taxes (if not claimed as a credit) | Yes |
Not Deductible (FIB)
Remember the mnemonic FIB — the following taxes are never deductible as itemized deductions:
- Federal income taxes
- Inheritance and estate taxes (state-level)
- Business taxes (deducted on Schedule C/E, not Schedule A)
Also not deductible: federal excise taxes, Social Security taxes, customs duties, and fines/penalties.
The $10,000 SALT Cap
Under the TCJA, the total itemized deduction for state and local taxes is limited to $10,000 per return ($5,000 for married filing separately). This cap applies to the combined total of income/sales taxes, real estate taxes, and personal property taxes.
The SALT cap does not apply to taxes paid in carrying on a trade or business (those are deducted on Schedule C or the applicable business schedule). It applies only to taxes deducted as personal itemized deductions on Schedule A.
Example
Sarah pays $8,000 in state income taxes, $4,500 in real property taxes, and $600 in personal property taxes during 2025, for a total of $13,100. Her SALT deduction is limited to $10,000.
Charitable Contributions to a Public Charity
Charitable contributions are a common itemized deduction on Schedule A. The tax treatment differs depending on whether the donation is cash or non-cash property.
Cash Contributions
Deduction Limit
Cash contributions to a public charity are deductible up to 60% of your Adjusted Gross Income (AGI) in the year the contribution is made.
What Counts as Cash
"Cash" contributions include:
- Actual cash
- Checks
- Credit card payments
- Payroll deductions
Carryovers
If your total cash contributions exceed the 60% AGI limit, the excess carries forward for up to 5 years, subject to the same 60% limit each year.
Order of Deduction
When a taxpayer has multiple types of contributions, cash is deducted first because it carries the highest AGI limit (60%). The order is:
- Cash contributions (up to 60% of AGI)
- Ordinary income property (up to 50% of AGI)
- Long-term capital gain (LTCG) property (up to 30% of AGI)
Substantiation
Proper records are required to claim the deduction, such as:
- Canceled checks
- Credit card statements
- Written acknowledgment from the charity (required for donations of $250 or more)
Example
If your AGI is $55,000, the maximum cash contribution deduction is:
If you contributed $19,500 this year and have a $5,000 carryover from the prior year, your total deductible amount is $24,500—well under the $33,000 limit, so the full amount is deductible.
Non-Cash Contributions
Types of Non-Cash Property
| Property Type | Description |
|---|---|
| Ordinary Income Property | Property that would generate ordinary income or short-term capital gain if sold (e.g., inventory, assets held ≤ 1 year, depreciated personal-use assets) |
| Long-Term Capital Gain (LTCG) Property | Appreciated property held for more than one year (e.g., stocks, real estate, collectibles) |
Deduction Amount
- Ordinary Income Property: Deduct the lesser of adjusted basis or fair market value (FMV) at the time of donation.
- LTCG Property: Deduct the FMV at the time of contribution.
AGI Limits
| Property Type | AGI Limit |
|---|---|
| Ordinary Income Property | 50% of AGI |
| LTCG Property | 30% of AGI |
Overall Limit
| Contribution Type | Overall Limit |
|---|---|
| Cash only | 60% of AGI |
| Mix of cash and property | 50% of AGI |
When both cash and non-cash property are donated in the same year, the combined deduction is generally limited to 50% of AGI.
Order of Applying Limits
- Cash contributions — deducted first (up to 60% of AGI if cash only, otherwise counted toward the 50% overall cap)
- Ordinary income property — deducted next (up to 50% of AGI)
- LTCG property — deducted last (up to 30% of AGI)
Carryover
If total contributions exceed the applicable limits, the excess carries forward for up to 5 years, subject to the same percentage limits each year.
Example
Assume AGI = $100,000, with the following donations:
- $10,000 of ordinary income property
- $30,000 of LTCG property
Applying the limits:
Total donated = $40,000, which is under the $50,000 overall cap. The full $40,000 is deductible ($10,000 ordinary income property + $30,000 LTCG property).
Non-cash contributions carry lower AGI limits than cash. When combined with cash donations, the overall deduction is generally capped at 50% of AGI. Any unused deduction can be carried forward for up to 5 years.
Deductible Interest Expense
For individual taxpayers, the deductibility of interest expense depends heavily on the purpose of the underlying debt. The IRS categorizes interest into several buckets, each with its own distinct rules. For the CPA exam, the most heavily tested categories are Qualified Residence Interest and Personal (Consumer) Interest.
1. Qualified Residence Interest (Mortgage Interest)
Taxpayers can deduct interest paid on debt secured by a qualified residence (their main home and one other qualifying second home) as an itemized deduction on Schedule A. However, the debt must meet the definition of Acquisition Indebtedness.
Acquisition Indebtedness is debt incurred to buy, build, or substantially improve the qualified residence that secures the loan.
The TCJA Limitation: Under the Tax Cuts and Jobs Act (TCJA), for debt incurred after December 15, 2017, the deduction is limited to interest paid on up to $750,000 of qualified acquisition indebtedness ($375,000 if married filing separately).
- Note: Grandfathered debt incurred on or before December 15, 2017, is subject to the older, higher limit of $1,000,000 ($500,000 if married filing separately).
Home Equity Loans: The treatment of home equity loans or lines of credit (HELOCs) relies entirely on how the borrowed funds are used:
-
Deductible: If the proceeds of a home equity loan are used to buy, build, or substantially improve the home that secures the loan, the interest is deductible (subject to the combined $750,000 debt limit).
-
Not Deductible: If the proceeds are used for personal living expenses (e.g., paying off credit card debt, taking a vacation, or buying a car), the interest is not deductible.
2. Personal (Consumer) Interest
Personal interest is never deductible. This is a strict rule and a frequent distractor on exam questions. Common examples of non-deductible personal interest include:
- Interest on auto loans (unless the vehicle is used for business)
- Credit card finance charges
- Interest on personal signature loans
- Late payment charges by a public utility
Application in Practice: The Champaign Scenario
Scenario: On March 1, Year 1, David and Elena paid $60,000 down and obtained a $400,000 mortgage to purchase their primary residence in Champaign. In Year 4, they took out a $45,000 home equity line of credit (HELOC) secured by their home, using the funds entirely to remodel their kitchen and upgrade their HVAC system. That same year, they took out an $8,000 personal loan to purchase high-end computer components for a personal hobby.
The following information pertains to interest paid in Year 4:
- Primary mortgage interest: $22,000
- HELOC interest (kitchen/HVAC remodel): $3,100
- Personal loan interest (computer components): $650
Question: For Year 4, how much interest is deductible as an itemized deduction?
Step 1: Analyze the Primary Mortgage
- Debt Amount: $400,000
- Purpose: To purchase the primary residence (Acquisition Indebtedness).
- Limit Check: The $400,000 debt is well under the $750,000 TCJA threshold.
- Conclusion: The entire $22,000 of mortgage interest is fully deductible.
Step 2: Analyze the Secondary Loan (HELOC)
- Debt Amount: $45,000
- Purpose: To remodel the kitchen and upgrade systems (Substantial Improvement).
- Limit Check: Total qualified debt is now $445,000 ($400,000 primary + $45,000 HELOC). This combined total is still well under the $750,000 limit.
- Conclusion: Because the HELOC proceeds were used to substantially improve the residence that secures the loan, it qualifies as acquisition indebtedness. The $3,100 of interest is fully deductible.
Step 3: Analyze the Personal Loan
- Debt Amount: $8,000
- Purpose: Purchasing computer components for personal use.
- Conclusion: This is consumer interest. The debt is not secured by the home, and the proceeds were not used to buy, build, or improve a home. The $650 of interest is not deductible.
Final Calculation: Total Deductible Interest = Primary Mortgage Interest ($22,000) + Improvement Loan Interest ($3,100) = $25,100.
The Tax Benefit Rule: State Income Tax Refunds
In federal income taxation, the Tax Benefit Rule under IRC §111 provides that a recovery of an amount deducted in a prior year is included in gross income only to the extent the earlier deduction actually reduced the taxpayer's tax liability.
For CPA exam purposes, this rule most often appears in questions involving state and local tax (SALT) refunds.
1. The Core Principle
A state income tax refund is not automatically taxable. Its treatment depends on how the taxpayer filed in the year the taxes were originally paid.
- Standard Deduction: If the taxpayer claimed the standard deduction in the prior year, no separate deduction was taken for state income taxes. As a result, the refund is nontaxable.
- Itemized Deductions: If the taxpayer itemized deductions, the refund is taxable only to the extent the itemized deductions exceeded the standard deduction.
2. The "Lesser Of" Calculation
To determine the taxable portion of a state tax refund, apply the following rule:
The taxable amount is the lesser of:
- The actual refund received in the current year.
- The amount by which the prior year's itemized deductions exceeded the standard deduction.
Comprehensive Example: The $800 Refund
A taxpayer receives an $800 state income tax refund in the current year for taxes paid and deducted in the prior year. Assume the prior year standard deduction was $14,600.
Case A: Limited Tax Benefit
In this scenario, the taxpayer's itemized deductions were only slightly above the standard deduction.
- Prior Year Total Itemized Deductions: $15,100
- Prior Year Standard Deduction: $14,600
- Tax Benefit Amount: $15,100 - $14,600 = $500
Taxable Amount: $500
Although the taxpayer received an $800 refund, the prior deduction only produced a $500 tax benefit above the standard deduction floor. Therefore, only $500 is included in gross income.
Case B: Full Tax Benefit
In this scenario, the taxpayer's itemized deductions were significantly higher than the standard deduction.
- Prior Year Total Itemized Deductions: $16,000
- Prior Year Standard Deduction: $14,600
- Tax Benefit Amount: $16,000 - $14,600 = $1,400
Taxable Amount: $800
Because the taxpayer's prior tax benefit of $1,400 exceeds the $800 refund received, the entire refund is taxable.
Summary Table
| Item | Case A (Limited Benefit) | Case B (Full Benefit) |
|---|---|---|
| Refund Received | $800 | $800 |
| Total Itemized Deductions | $15,100 | $16,000 |
| Standard Deduction Floor | ($14,600) | ($14,600) |
| Tax Benefit Amount | $500 | $1,400 |
| Taxable Portion of Refund | $500 (lesser of $800 or $500) | $800 (lesser of $800 or $1,400) |
CPA Exam Key Takeaways
- Standard Deduction = $0 Taxable Refund: If the taxpayer did not itemize in the prior year, the refund is nontaxable.
- Apply the Lesser-Of Rule: The taxable amount is the lesser of the refund received or the amount by which itemized deductions exceeded the standard deduction.
- Remember the SALT Cap: Under current law, the $10,000 SALT limitation can reduce the taxable portion of a refund. If a taxpayer paid $12,000 of state taxes but could deduct only $10,000, the first $2,000 did not create a tax benefit. For example, if that taxpayer later receives a $3,000 refund, only $1,000 is generally taxable because the first $2,000 merely reverses taxes that were never deducted.
Casualty and Theft Losses
Under the TCJA, personal casualty and theft losses are deductible only if attributable to a federally declared disaster. This restriction applies through 2025.
Computing the Deduction
The deductible casualty loss is computed as follows:
- Determine the loss amount: the lesser of (a) the decline in FMV or (b) the taxpayer's adjusted basis in the property
- Subtract any insurance or other reimbursement
- Subtract $100 per casualty event (the per-event floor)
- Subtract 10% of AGI from the total of all casualty losses (the aggregate floor)
Example
A federally declared tornado damages Marcus's personal residence. The home had a basis of $300,000 and the decline in FMV due to storm damage is $40,000. Insurance reimburses $25,000. Marcus's AGI is $90,000.
| Step | Calculation |
|---|---|
| Loss (lesser of FMV decline or basis) | $40,000 |
| Less: insurance reimbursement | ($25,000) |
| Net loss | $15,000 |
| Less: $100 per-event floor | ($100) |
| Loss after per-event floor | $14,900 |
| Less: 10% of AGI ($90,000 × 10%) | ($9,000) |
| Deductible casualty loss | $5,900 |
If the casualty is not in a federally declared disaster area, the personal casualty loss is not deductible under current law (TCJA, through 2025). Business casualty losses are not subject to this restriction.
Gambling Losses
Gambling losses are deductible as an itemized deduction, but only to the extent of gambling winnings reported in gross income. The taxpayer must itemize to claim the deduction — it is not available to those who take the standard deduction.
- Gambling winnings include proceeds from lotteries, raffles, horse races, casinos, and other wagering activities.
- The taxpayer must maintain adequate records (receipts, tickets, statements) to substantiate both winnings and losses.
- Excess gambling losses cannot be carried forward to future years.
Example
Illini Entertainment sponsors a corporate retreat at a casino. Jamie, an employee attending on personal time, wins $4,200 at poker and loses $6,500 at blackjack during the year. Jamie includes $4,200 in gross income and may deduct up to $4,200 of gambling losses as an itemized deduction. The remaining $2,300 of losses is not deductible.
Section 199A Qualified Business Income (QBI) Deduction
The Section 199A deduction allows eligible taxpayers to deduct up to 20% of qualified business income (QBI) from a pass-through entity or sole proprietorship. This deduction is taken below the line (after AGI) but is available whether or not the taxpayer itemizes — it is not an itemized deduction.
Basic Calculation
The deduction is limited to the lesser of:
- 20% of QBI, or
- 20% of taxable income (before the Section 199A deduction)
Qualified Trade or Business (QTB) vs. Specified Service Trade or Business (SSTB)
| Category | Description | Examples |
|---|---|---|
| QTB | Any trade or business other than an SSTB or the business of being an employee | Manufacturing, retail, real estate, construction |
| SSTB | A trade or business involving the performance of services in specified fields | Health, law, accounting, consulting, athletics, financial services, brokerage |
At lower income levels, the SSTB distinction does not matter — the full 20% deduction is available regardless of business type. The SSTB limitation only kicks in once taxable income exceeds the threshold.
Income Thresholds (2025 Approximate)
| Filing Status | Full Deduction Below | Phase-Out Range | No SSTB Deduction Above |
|---|---|---|---|
| Single / HoH | $197,300 | $197,300 – $247,300 | $247,300 |
| MFJ | $394,600 | $394,600 – $494,600 | $494,600 |
W-2 Wages and Property Limitations
For taxpayers with taxable income above the threshold, the QBI deduction for each QTB is limited to 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
These limitations ensure that the deduction benefits businesses with substantial payroll or capital investment.
Example
BIF Partners operates a landscaping business (a QTB, not an SSTB). The partnership allocates $180,000 of QBI to Sarah, who files as Single with taxable income of $160,000 (below the threshold). Sarah's Section 199A deduction:
Because Sarah's taxable income is below the threshold, the W-2/property limitations do not apply, and the full $36,000 deduction is allowed (subject to the 20% of taxable income cap).
Example — SSTB Above Threshold
Priya is a partner in an accounting firm (an SSTB). Her allocated QBI is $300,000 and she files as Single with taxable income of $260,000 — above the $247,300 upper threshold. Because the accounting firm is an SSTB and Priya's income exceeds the phase-out range, her Section 199A deduction is $0. No QBI deduction is available for income from an SSTB once taxable income exceeds the upper threshold.
:::tip CPA Exam Strategy
For Section 199A questions, follow this decision tree:
- Is the income from a qualified trade or business?
- Is the taxpayer's taxable income below the threshold? → Full 20% deduction.
- Is it an SSTB with income above the upper threshold? → No deduction.
- Is it a QTB with income above the threshold? → Apply W-2/property limitations.
:::