The House-approved tax reconciliation bill (H.R. 1, the Bill), which consists of the underlying budget reconciliation bill and a manager's amendment, would make the qualified business income (QBI) deduction under IRC Section 199A permanent and extend its provisions. (See Tax Alert 2025-1075 for a discussion of the Bill's international tax provisions, Tax Alert 2025-1069 for discussion of proposed changes to energy credits enacted under the Inflation Reduction Act, and Tax Alert 2025-1161 for a discussion of the Bill's provisions affecting high-income taxpayers.)

QBI deduction

Current law

Under current law, non-corporate taxpayers are allowed a deduction under IRC Section 199A based on QBI from a qualified trade or business carried on by the taxpayer or from qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deductible amount from a trade or business is 20% of the QBI (the net amount of qualified income, gain, deduction, and loss, with certain exclusions). The deductible amount from a trade or business cannot be greater than a trade or business wage (or wage and qualified property basis) limitation. A qualified trade or business excludes a specified service trade or business (SSTB), which includes many professional services businesses (e.g., health, law, accounting, consulting, investment management, and securities trading or dealing). The combined amounts of deductible trade or business QBI cannot be greater than 20% of the taxpayer's taxable income (in excess of net capital gain). The exclusion for SSTBs and the trade or business wage/property basis limitations do not apply to taxpayers with taxable income equal to or less than a threshold amount. QBI from an SSTB is allowed, under a phase-in limitation, for some taxpayers with income greater than the threshold amount.

There are no statutory partnership or S corporation information reporting requirements specific to the IRC Section 199A deduction.

IRC Section 199A does not apply to tax years beginning after December 31, 2025.

Proposal

The Bill would make IRC Section 199A permanent, increase the deduction rate from 20% to 23%, replace the phase-in limitation for QBI from an SSTB and extend the deduction to business development corporation (BDC) interest dividends.

The new rules governing phase-out of the deduction for taxpayers with taxable income in excess of the annual threshold would permit the taxpayer to deduct the greater of two amounts from trades or businesses carried on by the taxpayer:

1. The deduction based on 23% of qualified business income, and after applying all relevant limitations, including those based on W-2 wages, capital investment, and status as an SSTB. For taxpayers with taxable income in excess of the annual threshold, the amount related to any SSTB will always be zero.
2. The deduction based on 23% of qualified business income, but without applying any limitations based on W-2 wages, capital investment, or status as an SSTB. This amount would then be reduced by 75% of the excess of taxable income over the annual threshold.

The greater of these two amounts, and 23% of the aggregate qualified REIT dividends, qualified BDC interest dividends, and qualified publicly traded partnership income would be the taxpayer's deduction under IRC Section 199A(a) (unless 23% of the taxpayer's taxable income (in excess of net capital gains) is less).

The Bill would add "qualified BDC interest dividends" to the types of income that would be included as the "combined qualified business income amount" under IRC Section 199A(b)(1). Qualified BDC interest dividends would be defined in IRC Section 199A(e)(5) as any dividend from an electing BDC received during the tax year that is attributable to the net interest income of the company and is properly allocable to a qualified trade or business of the company. An electing business development company would be defined as a business development company (as defined in 15 U.S.C section 80a-2(a)(48)) that has an election in effect under IRC Section 851 to be treated as a regulated investment company.

The Bill would also amend IRC Sections 6031 (Return of partnership income) and 6037 (Return of S corporation) to require that partnership and S corporation returns include a statement of whether the partnership or S corporation had any gross receipts from an SSTB.

Effective date

Amendments made by the Bill would apply to tax years beginning after December 31, 2025.

Implications

The Bill would significantly expand the number of taxpayers that can take advantage of the IRC Section 199A deduction, as this change would provide new opportunities for higher-income SSTB owners who previously may have been excluded. Under the current law, there is a fixed taxable income ceiling for applying the phase-in limitation for QBI from an SSTB. Under the proposal, the limitation would be based on two variables: the taxable income of the taxpayer and the QBI from SSTBs. Taxpayers with high taxable income and a large deductible SSTB QBI amount would benefit more than a taxpayer with low taxable income and a large deductible SSTB QBI amount, as the 23% taxable income limitation for the deduction would not be as great a barrier as for a taxpayer with lower taxable income. A taxpayer with high taxable income and a small deductible SSTB QBI amount would likely not benefit, as 75% of the difference between taxable income and the threshold amount would likely reduce the small deductible SSTB QBI amount below zero.

The partnership and S corporation return disclosure requirement would allow taxpayers receiving information from a pass-through entity to be able to more easily identify opportunities to claim an IRC Section 199A deduction. Although current regulations under IRC Section 199A provide information reporting requirements, the IRC does not.

As noted, the Bill would expand the deduction to net interest income returns received by US investors in certain BDCs. BDCs are investment funds engaged in making loans and/or investing in debt and, as such, earn interest income. The BDC fund structure in the context of the private investment industry is used as needed when making debt investments that may include foreign investors. This change would essentially extend the IRC Section 199A favorable treatment of REIT dividends to applicable BDC dividends.

According to the Joint Committee on Taxation's analysis of the revenue effects of the Bill (JCX-26-25), changes to IRC Section 199A would reduce revenues by $819.7B over the 10-year budget window.