2026 Section 199A: Is your service business out of favor?

Tax code Section 199A gives you a 20 percent tax deduction if you have

Pass-through business income (such as from a proprietorship, a partnership, or an S corporation), and
2026 taxable income of $403,500 or less (married, filing jointly) or $201,750 or less (filing as single or head of household)

But once your taxable income is greater than the amounts mentioned above (which Section 199A calls “thresholds”), your Section 199A tax deduction becomes more complicated.

Under the rules that apply to the Section 199A tax deduction, the tax code creates two types of businesses:

Businesses that are in favor and can realize the deduction regardless of taxable income.
Businesses that are out of favor. The tax code calls the out-of-favor business a “specified service trade or business” (SSTB).

If you own an out-of-favor SSTB, you suffer a zero Section 199A tax deduction on that business’s out-of-favor income when you have 1040 taxable income greater than $553,500 (married, filing jointly) or $276,750 (single or head of household)

Yes, still zero. The One Big Beautiful Bill Act (OBBBA) added a $400 minimum Section 199A deduction beginning in 2026.

It applies below the thresholds when you have atleast $1,000 of qualified business income from an in-favor or out-of-favor trade or business in which you materially participate.
It applies to an in-favor business that’s above the phase out.
It does not apply to a out-of-favor SSTB that’s above the phaseout/phase in.

This is one more reason to care about the de minimis rules described later in this article. Carve out a genuine in-favor business, and you have qualified business income again, which puts the $400 minimum back on the table along with the real deduction on the in-favor income.

With taxable income greater than the $403,500/$201,750 thresholds and less than the $553,500/$276,750 upper limits, Section 199A reduces the tax deduction available to your out-of-favor SSTB.

Good news for taxpayers in the phase-in band: the One Big Beautiful Bill Act (OBBBA) expanded the phase-in range by 50%, starting in 2026. For single filers, the band now stretches from $50,000 to $75,000 above the threshold; for married filers, from $100,000 to $150,000 above the threshold. If you own a specified service trade or business (SSTB), this wider band is where a partial QBI deduction is available—and it’s now 50% larger than before.

And it is permanent. Section 199A was scheduled to expire after 2025. The OBBBA repealed the sunset, so the planning in this article pays off every year, not just this one time.

One technical point for 2026: you compute taxable income for Section 199A purposes without regard to the new limitation on itemized deductions.

This brings us to the questions that are answered:

What if your taxable income is above the limits, but your pass-through business has one part that’s out of favor and another part that’s in favor? You will like what the rules have done for you in this situation.
What service business gives the “big picture” of how the out-of-favor SSTB definitions work? Answer: consulting. We will dive into the rules that apply to consulting, because almost any business could have some consulting activity.

How the definitions work

Big picture. For definitions of out-of-favor SSTBs under Section 199A, don’t look to the tax code sections other than Section 199A.

The IRS says that the 199A service definitions stand alone even though the IRS itself borrows sentences and paragraphs from its other regulations and uses them in the Section 199A final regulations.

For example in its Section 199A regulations, the IRS uses many sentences, phrases and words from the Section 448 regulations, which define “personal service corporations” by looking at the services provided by both the owner and the corporation.

The Section 199A regulations apply to the business of performing services and look to the business regardless of whether the owner is passive or participates in any of the business’s activities.

To make clear what’s going on here, the IRS in is final Section 199A regulations

Contracted and expanded the “personal service” definitions beyond those provided in IRS Regulation Section 1.448-IT(e )(4), and
Specified that the final regulations, from determining Section 199A out-of-favor SSTB status, apply solely for purposes of Section 199A. They may not be taken into account for purposes of applying any other provision of law, except to the extent that another provision expressly refers to Section 199A(d).

To explore the less-favorable SSTB definitions, we focused on consulting. Because the consulting category can apply to many types of businesses, its broad scope helps illustrate how the rules might be structured to your advantage.

Consulting as defined by Section 199A

According to the IRS, “consulting” means providing professional advice and counsel to clients to help them achieve their goals and solve problems.

Consulting also covers providing advice and counsel related to advocacy, including efforts intended to influence decisions made by government or governmental agencies. This includes all activities by lobbyists and similar professionals acting in that capacity to influence legislators and other government officials on behalf of a client.

The performance of services in the field of consulting does not include performances of services other than advice and counsel, such as sales or the provision of training and educational courses. Differentiating sales from consulting activity requires an examination and assertion of the facts and circumstances.

Planning point. The IRS generally considers separate billing for advice as consulting and not part of goods, services, training, or education.

Example: Mike is a building contractor remodeling a client’s bathroom. If Mike does not separately bill for any consultation on the bathroom project, he has no out-of-favor SSTB business income from the remodel.

Good congressional lobbying at work: services and advice provided by architects and engineers are explicitly excluded from the definition of consulting. As a result, these businesses are treated as “in favor.” Credit goes to effective lobbying by the architecture and engineering sectors.

Out of favor SSTB: Donna

Donna is in the business of helping clients make their personnel structures more efficient. She studies the client’s organization and structure and compares it to those of peers in the client’s industry. Donna then makes recommendations and provides advice to her client regarding possible changes in the client’s personnel structure, including the use of temporary workers.

Donna is in the business of consulting – this is a Section 199A out-of-favor SSTB.

In favor: Ed

Ed owns and operates a temporary-worker staffing firm that primarily serves the software consulting industry. Business clients engage Ed to arrange for temporary workers with technical skills and experience across a range of business software. These temporary workers provide consulting and advice on selecting and using the software best suited to each client’s needs.

Ed does not have a technical software engineering background and does not provide software consulting advice himself.

Ed reviews resumes and refers candidates when his business clients indicate a need for temporary workers. He does not evaluate his clients’ need for workers and does not evaluate the clients’ consulting contracts to determine the type of expertise needed.

Rather, the client provides Ed with a job description indicating the required skills for the upcoming consulting project, and then pays Ed a fixed fee for each temporary workers actually hired plus a bonus if that worker is hired permanently within a year of referral.

Ed’s fee is not contingent on the profits of his clients.

Ed is not a Section 199A consulting business. He operates an in-favor business.

In favor: Fred

Fred is in the business of licensing software to customers. He discusses and evaluates the customer’s software needs with the customer, and then advises the customer on the particular software products it licenses.

The customer pays Fred a flat price for the software license. After the customer licenses the software, Fred helps implement the software.

Fred is in the in-favor business of licensing software and not the out-of-favor business of consulting,

Doing two or more things: The De Minimis Rule

The regulations make it clear that you can benefit from the de minimis rule.

The rule. If the trade or business has annual gross receipt of $25 million or less-and if it gets less than 10 percent of its gross receipts from an out-of-favor SSTB, such as consulting-it is an in-favor business.

If gross receipts are greater than $25 million, substitute 5 percent for the 10 percent.

Note that the $25 million figure is fixed in the regulation and is not adjusted for inflation. As receipts grow over the years, more businesses land on the 5 percent side of the line.

De Minimis Example1

Landscape LLC sells lawn care and landscaping equipment and also provides advice and counsel on landscape design for large office parks and residential buildings.

The landscape design services include advice on the selection and placement of trees, shrubs, and flowers and are considered under Section 199A as an out-of-favor consulting business.

Landscape LLC separately invoices for its landscape design services and does not sell the trees, shrubs, or flowers it recommends for use in the landscape design. Landscape LLC maintains one set of books and records and treats the equipment sales and design services as a single trade or business.

Landscape LLC has gross receipts of $2 million, of which $250,000 is attributable to the landscape design services, a consulting business. Because consulting services are 10 percent or more of total gross receipts, the entirely of Landscape LLC’s trade or business is an out-of-favor SSTB.

De Minimis Example 2

Animal Care LLC provides veterinarian service performed by licensed staff and also develops and sells its own line of organic dog food at its veterinarian clinic and online.

The veterinarian services are in the out-of-favor SSTB of health care.

Animal Care LLC separately invoices for its veterinarians services and the sale of its organic dog food. It maintains separate books and records for its veterinarian clinic and its development and sale of its dog food.

Animal Care LLC also has separate employees who are unaffiliated with the veterinary clinic and who work only on the formulation, marketing, sales, and distribution of the organic dog food products.

Animal Care LLC treats its veterinary practice and the dog food development and sales as separate trades or businesses for purpose of Section 162 and 199A. It has gross receipts of $3 million. Of the gross receipt, $1 million is attributable to the out-of-favor veterinary services.

Although the gross receipts from the services in the field of health exceed 10 percent Animal Care LLC’s total gross receipts, the dog food business is a separate in-favor business.

Note the Animal Care wins because it has two trades or businesses, which it proves with its separate financial books and its separation of its employees.

Landscape, in the previous example, failed because it had one business only, which it also proved by the way it kept its books.

You may not aggregate an SSTB with anything else for Section 199A purposes. So the in-favor business has to stand on its own books, its own invoices, and ideally its own employees.

BergerCPAFirst, with over 35+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalized attention while ensuring compliance and maximizing tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or send us an inquiry.