Qualified Business Income (QBI) W-2 wages are a key component in calculating the QBI deduction under Section 199A of the Internal Revenue Code. This deduction, introduced by the Tax Cuts and Jobs Act of 2017, allows eligible taxpayers to deduct up to 20% of their QBI from certain pass-through entities (like sole proprietorships, partnerships, S corporations, and certain trusts and estates). The W-2 wages limitation is one of the factors that can limit the deduction, particularly for higher-income taxpayers.
Here’s an explanation of what can be included in QBI W-2 wages:
Definition of QBI W-2 Wages
QBI W-2 wages are the total wages paid by a qualified trade or business to its employees, which are used to calculate the QBI deduction limitation. These wages are subject to specific rules and must meet certain criteria to be included.
What Can Be Included in QBI W-2 Wages
The IRS defines W-2 wages for QBI purposes as amounts reported on Form W-2 that meet the following criteria:
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Wages Subject to Federal Income Tax Withholding:
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Wages, salaries, bonuses, commissions, and other compensation paid to employees that are reported in Box 1 of Form W-2 (Wages, Tips, Other Compensation).
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These must be subject to federal income tax withholding, as reported in Box 2 of Form W-2.
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Elective Deferrals and Deferred Compensation:
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Amounts that employees elect to defer, such as contributions to 401(k) plans, 403(b) plans, or other qualified retirement plans, reported in Box 12 of Form W-2 with codes like D, E, F, G, or S.
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Certain deferred compensation amounts, such as contributions to nonqualified deferred compensation plans, may also be included if they meet IRS requirements.
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Medicare Wages:
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Wages reported in Box 5 of Form W-2 (Medicare wages and tips) can be included, as they often align with amounts subject to federal income tax withholding.
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Allocable to the Qualified Business:
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The wages must be properly allocable to the specific qualified trade or business generating the QBI. If a taxpayer operates multiple businesses, only the W-2 wages attributable to the qualified business are included.
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Paid During the Tax Year:
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The wages must be paid in the taxable year for which the QBI deduction is being calculated.
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For accrual-basis taxpayers, wages must be properly accrued and reported on Forms W-2 filed for the calendar year ending with or within the taxable year of the business.
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What Is Not Included in QBI W-2 Wages
Certain types of payments or amounts are excluded from QBI W-2 wages, including:
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Payments to Independent Contractors: Compensation paid to non-employees (e.g., 1099 contractors) does not count as W-2 wages.
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Wages Not Subject to Withholding: Any payments not subject to federal income tax withholding (e.g., certain fringe benefits or non-taxable reimbursements) are excluded.
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Owner’s Compensation:
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For sole proprietors, guaranteed payments to partners in a partnership, or wages paid to S corporation shareholders for services are not included, as these are not considered employee wages.
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Wages Not Allocable to QBI:
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Wages paid for activities not related to the qualified trade or business (e.g., wages from a separate non-qualified business or personal activities) are excluded.
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How QBI W-2 Wages Are Used
The QBI deduction is generally 20% of QBI, but for taxpayers with taxable income above certain thresholds ($182,100 for single filers or $364,200 for joint filers in 2025, adjusted annually), the deduction is limited to the lesser of:
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20% of QBI, or
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The greater of:
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50% of the W-2 wages paid by the qualified business, or
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25% of the W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.
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Thus, accurately calculating W-2 wages is critical for taxpayers subject to these limitations.
Key Considerations
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Reporting Requirements: The business must file Forms W-2 with the Social Security Administration (SSA) by the due date (generally January 31 of the following year) for wages to be considered in the QBI calculation.
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Aggregation Rules: If a taxpayer aggregates multiple businesses for QBI purposes, the W-2 wages from all aggregated businesses can be combined.
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Specified Service Trade or Business (SSTB): For SSTBs (e.g., law, accounting, consulting), the QBI deduction phases out for high-income taxpayers, but W-2 wages still play a role in determining the allowable deduction during the phase-out range.
Example
Suppose a partnership operates a qualified business and pays $100,000 in wages to employees, reported on Forms W-2 (Box 1) and subject to withholding. Additionally, employees defer $10,000 into a 401(k) plan (reported in Box 12). The QBI W-2 wages would include the $100,000 in wages plus the $10,000 in elective deferrals, totaling $110,000, assuming all wages are allocable to the qualified business.
Additional Resources
For precise calculations, taxpayers should refer to IRS regulations under Section 199A, particularly Treas. Reg. § 1.199A-2, or consult a tax professional. The IRS also provides guidance through Form 8995 or 8995-A and their instructions.