Why Wages Can Limit the QBI Deduction (Even When You Qualify)

One of the most frustrating QBI surprises happens after business owners think they’ve done everything right.

They:

qualify for the QBI deduction
earn strong income
run a legitimate business

…and still find the deduction is smaller than expected.

The reason usually comes down to one word:

Wages.

A Quick Recap of Where We Are

If you’re reading this in order, here’s what we’ve already covered:

This post answers the next logical question:

If I qualify for the QBI deduction, why am I still being limited?

The QBI Deduction Has a Second Gate: Wages

Once income rises above certain thresholds, the QBI deduction stops being a simple percentage of profit.

Instead, it becomes tied to how the business pays people and how much capital it uses.

At that point, the deduction is limited by one of these formulas:

50% of W-2 wages paid by the business, or
25% of W-2 wages + 2.5% of qualified property

This is known as the wage and capital limitation.

You don’t need to memorize the math yet — but you do need to understand the intent.

Why Wages Matter at All

The QBI deduction wasn’t designed to reward income alone.

It was designed to encourage:

job creation
payroll growth
long-term business investment

So once income reaches higher levels, the IRS asks:

“Is this business contributing to the broader economy — or just generating profit?”

Payroll is how that question gets answered.

The Most Common Surprise

Here’s where many business owners get caught off guard:

A highly profitable business with little or no payroll may see its QBI deduction capped — or eliminated — even if it otherwise qualifies.

This happens frequently with:

solo business owners
S corporations with very low salaries
businesses that outsource most work
service businesses that rely heavily on the owner

A Simple Example

Imagine two business owners earning the same profit.

Owner A

Runs an S corporation
Pays themselves a modest W-2 salary
Has employees on payroll

Owner B

Runs a similar business
Takes most income as distributions
Has little or no payroll

As income rises:

Owner A may still qualify for a meaningful QBI deduction
Owner B may see the deduction sharply limited

Same income.
Different wage structure.
Different outcome.

Why This Especially Affects S Corporations

S corporations sit at the center of many QBI questions because:

Owners must pay themselves a reasonable salary
W-2 wages are tracked explicitly
Distributions don’t count as wages

That creates a planning tension:

Lower salary → lower payroll taxes
Higher salary → potentially larger QBI deduction

There’s no universal “right” answer — but ignoring wages entirely often backfires.

What About Equipment and Property?

Some businesses qualify under the capital-based formula instead.

This matters for businesses that:

own equipment
hold real estate
use depreciable assets to generate income

In those cases, the 2.5% of qualified property component can preserve some of the QBI deduction even when payroll is low.

This is why capital-intensive businesses often fare better under QBI rules than service-heavy ones.

Can Planning Help Here?

Sometimes — but only within limits.

Important reality check (and exam favorite):

Increasing wages solely to increase the QBI deduction does not always improve total tax outcomes.

Payroll taxes, cash flow, and business structure all matter.

Good planning looks at:

total tax cost
sustainability
compliance
not just the size of one deduction

Why This Is the Final QBI Piece

At this point in the series, you now understand:

what the QBI deduction is
when income changes it
which businesses lose it
why wages can cap it

This is the full framework the exam expects you to reason through — not memorize.

Key Takeaway

The QBI deduction is not just about income.

It’s about:

how income is earned
how people are paid
how capital is used

Once income rises, wages stop being optional.

Official IRS Reference

For authoritative guidance on wage and capital limits, click here