Qualified Business Income
The 20% Deduction in Trusts
If the trust owns a share of a business, a partnership interest, or rental property that qualifies, it may be entitled to a 20% deduction on that income. But whether the trust or the beneficiaries get to use the deduction depends on how distributions are handled. The wrong approach can cost the family thousands in lost tax savings.
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What the QBI deduction is
Section 199A of the tax code provides a 20% deduction on income from certain businesses. If you own a share of a partnership, an S corporation, or a sole proprietorship, you can deduct 20% of the net income from that business before calculating your tax. This deduction was created to give pass-through business owners a benefit comparable to the corporate tax rate reduction.
Trusts and estates qualify for the same deduction. If the trust holds an interest in a qualifying business, the business income that flows to the trust can generate a 199A deduction.
How it works when a trust is involved
When a trust receives qualified business income, the deduction is split between the trust and the beneficiaries based on how much income the trust distributes. If the trust keeps the income, the trust claims the deduction on its own return. If the trust distributes the income to beneficiaries, each beneficiary claims their share of the deduction on their own return.
This split follows the same rules as all other trust income: the distribution deduction determines who reports the income, and the 199A deduction follows the income.
Why distributing income can save the deduction
Trusts are taxed at compressed rates. The trust reaches the highest federal tax bracket at roughly $16,000 in taxable income (2026), while an individual does not reach the same bracket until over $640,000. This compression matters for the 199A deduction because certain limitations kick in based on taxable income.
For some types of business income (service businesses like law firms, medical practices, and consulting firms), the deduction phases out entirely once the taxpayer’s income exceeds a threshold. Because trusts can exceed that threshold with relatively modest income, the deduction may be lost at the trust level. But if the trust distributes the income to beneficiaries whose income is below the threshold, the deduction is preserved.
This is one of the most significant planning opportunities for trusts that hold business interests. We model both scenarios (retain vs. distribute) as part of the annual 1041 preparation.
The service business catch
Not all business income is treated the same under Section 199A. Income from "specified service trades or businesses" (law, accounting, health care, consulting, financial services, and similar fields) faces stricter rules. Above the taxable income threshold, the deduction for service business income phases out and eventually disappears entirely.
For a trust retaining this type of income, the deduction can be lost. For beneficiaries with lower income, the deduction may survive. The trustee’s distribution decision directly controls the outcome.
Rental property in a trust
Rental income can qualify for the 199A deduction, but not always. The rental activity must rise to the level of a trade or business, which depends on the type of property, the services provided, and the level of involvement. The IRS has issued a safe harbor (Revenue Procedure 2019-38) that provides a clear path for certain rental real estate activities, but many passive rental arrangements do not meet the requirements.
If the trust holds rental property, we evaluate whether the activity qualifies and, if so, how to allocate the deduction between the trust and its beneficiaries.
What we handle
- Computing the 199A deduction on the trust return
- Tracking the allocation of QBI items to each beneficiary on their K-1
- Modeling whether distributing income preserves or improves the deduction
- Identifying which business interests qualify and which are service businesses
- Evaluating rental property for 199A eligibility
- Coordinating 199A planning with the 65-day rule and overall distribution strategy
Frequently Asked Questions
Does the trust automatically get the 20% deduction on business income?
The trust is eligible, but the deduction is not automatic. It depends on the type of business, the trust’s taxable income, and how much income the trust distributes. For some trusts, the deduction is straightforward. For others, particularly those with service business income or high retained income, limitations may reduce or eliminate it. We compute the deduction as part of the annual 1041 preparation.
Can the trustee distribute income specifically to preserve the deduction?
Yes. The trustee’s distribution decisions directly affect where the QBI deduction is computed. By distributing income to beneficiaries with lower taxable income, the deduction may survive limitations that would have eliminated it at the trust level. The 65-day rule also provides a window after year-end to make this decision with full-year numbers in hand. This is one of the most important planning tools available for trusts with business income.
What if the trust owns rental property? Does that qualify?
Rental income can qualify for the 199A deduction if the rental activity rises to the level of a trade or business. The IRS has provided a safe harbor (Revenue Procedure 2019-38) for certain rental real estate enterprises, but not all rentals qualify. The determination depends on the type of property, the level of services provided, and the hours of involvement. We evaluate each rental activity to determine eligibility.
Does this deduction expire?
Section 199A was originally set to expire after 2025 under the Tax Cuts and Jobs Act. It has been extended and remains in effect for 2026 and beyond. The rules and thresholds are indexed for inflation annually.
Related services
Trust Income Tax (Form 1041)
The 199A deduction is computed on the 1041 and allocated to beneficiaries through their K-1s.
The 65-Day Rule
A window after year-end to distribute income and shift the QBI deduction to beneficiaries.
Beneficiary K-1 Returns
Beneficiaries compute their share of the 199A deduction on their individual returns using K-1 data.