Tax Glossary

Adjusted Gross Income is your gross income reduced by specific 'above-the-line' adjustments — 401(k) contributions, HSA contributions, traditional IRA contributions, half of self-employment tax, student loan interest (capped), educator expenses. AGI is used to determine eligibility for many credits and deductions.

Effective rate is the average percentage of your income that goes to tax. Because lower income brackets are taxed at lower rates, your effective rate is always less than your marginal rate. It's the more honest measure of 'what percentage am I paying overall' — though marginal rate is what matters for decisions about additional income.

MAGI starts with AGI and adds back specific deductions like foreign earned income exclusion, student loan interest, certain IRA deductions. The exact add-backs vary by purpose (Roth IRA limits use a different MAGI than NIIT). For most W-2 employees with no foreign income, MAGI ≈ AGI.

Your marginal tax rate is the rate that applies to the next dollar of income you earn. The U.S. tax system is progressive, so different chunks of your income are taxed at different rates. Your marginal rate is your highest bracket — important for decisions like 'should I do this side gig' or 'should I exercise more ISOs'.

Almost every taxpayer takes the standard deduction — a simple flat amount the IRS lets you deduct without listing individual expenses. For 2026: $16,100 single / MFS, $32,200 married filing jointly, $24,150 head of household. The alternative is itemizing (mortgage interest, charity, state/local tax up to $40,400 for 2026 under OBBBA), which is only worth it if your itemized total exceeds the standard deduction.

Taxable income = total income − above-the-line adjustments (401k, HSA, etc.) − standard or itemized deduction. This is the figure that gets fed into the federal tax bracket math. Always lower than gross income or AGI.

The Tax Cuts and Jobs Act (TCJA), signed December 2017, was the largest federal tax overhaul since 1986. Key changes: standard deduction roughly doubled ($6,350 → $12,000 single), personal exemption eliminated, SALT deduction capped at $10,000, mortgage interest limited to $750K of acquisition debt, child tax credit doubled to $2,000, top corporate rate cut from 35% to 21%, §199A QBI 20% deduction added for pass-through income. Most individual-side provisions were scheduled to sunset after 2025; OBBBA (2025) extended many permanently and modified several — notably raising the SALT cap to $40K (with 2030 sunset), CTC to $2,200, and AMT phaseout/rate.

If you do contract or freelance work, clients who pay you $600+ in a year send a 1099-NEC. Unlike a W-2, no taxes are withheld — you're responsible for paying federal, state, FICA equivalent (self-employment tax 15.3%), and quarterly estimates. The flip side: you can deduct business expenses and contribute to a SEP-IRA or solo 401(k).

The One Big Beautiful Bill Act, signed July 2025, bundled the TCJA extension with several new individual provisions. Headline items: (1) SALT cap raised from $10,000 to $40,000 for 2025 ($40,400 for 2026, with 1% annual steps through 2029) — phases down 30¢/$ for MAGI > $500K, never below the $10K floor, sunsets back to $10K in 2030. (2) Child tax credit raised permanently from $2,000 to $2,200 (refundable portion $1,700 for 2026), phaseout unchanged at $200K/$400K. (3) Above-the-line 'No Tax on Overtime' deduction up to $12,500 single / $25,000 MFJ on the FLSA premium portion, phaseout $150K-$275K single / $300K-$550K MFJ, expires after 2028. (4) AMT exemption phaseout dropped to $500K single / $1M MFJ at a doubled 50% rate. (5) Estate and gift tax exemption raised permanently to $15M individual / $30M MFJ for 2026, indexed thereafter. (6) Companion 'No Tax on Tips' deduction up to $25,000 (also expires 2028). (7) §199A QBI 20% deduction made permanent with widened phase-in spreads ($75K single / $150K MFJ).

Time-and-a-half overtime pay has two components: the regular hourly rate (the '1×') and the overtime premium (the extra '0.5×' or 'half'). The OBBBA 'No Tax on Overtime' deduction applies only to the premium portion. So if you earn $30/hour and work 10 OT hours at $45/hour ($450 total), only the $150 premium portion ($15/hour × 10 hours) qualifies for the deduction — not the full $450.

Under the OBBBA 'No Tax on Overtime' deduction, only FLSA-mandated overtime counts — meaning hours actually worked beyond 40 in a workweek by non-exempt employees who are entitled to time-and-a-half pay by federal law. Voluntary 'premium pay' negotiated by union contract, shift differentials, or holiday-pay multipliers may not qualify. Salaried/exempt workers (managers, professionals, computer employees over $107,432) generally don't get FLSA OT and so don't qualify for the deduction.

Five U.S. states operate State Disability Insurance programs that withhold a percentage of wages to fund short-term disability benefits: California, New York, New Jersey, Rhode Island, and Hawaii. California's SDI is uniquely aggressive — post-2024 SB 951, the rate is 1.1% on every dollar of wages with NO upper limit. For high earners ($1M+ TC), CA SDI alone reaches $11K-$13K/year. Other state SDI programs cap at much lower wage thresholds. SDI is technically deductible federally as state tax; under OBBBA's expanded $40,400 SALT cap (2026), more high-income CA filers will get federal credit for SDI than under the prior $10K TCJA cap, though the cap phases down for MAGI > $500K.

If you're a regular employee, your employer issues a W-2 by January 31 each year. It shows your gross wages (Box 1), federal tax withheld (Box 2), Social Security and Medicare wages and tax (Boxes 3-6), state wages and tax (Boxes 16-17), and benefits like 401(k) contributions (Box 12). RSU vest income and ISO disqualifying dispositions also appear here.

Withholding is a prepayment of your tax bill, taken from each paycheck. Federal income tax withholding is based on your W-4 form. FICA (SS + Medicare) is fixed by law. State withholding follows state rules. At year-end, your total withholding is reconciled against your actual tax liability when you file. If too much was withheld → refund. If too little → you owe.

FICA is the law that funds Social Security and Medicare via payroll taxes. As an employee, you pay 6.2% Social Security on wages up to the wage base ($184,500 in 2026) plus 1.45% Medicare on all wages. Your employer pays a matching 7.65%. Self-employed people pay both halves (15.3%) but can deduct half on their tax return.

Medicare tax is 1.45% on every dollar of wages (no income cap). High earners pay an Additional Medicare Tax of 0.9% on wages above $200,000 (single) or $250,000 (MFJ) — that's a 2.35% combined rate at the top.

When you're self-employed (1099 contractor, sole proprietor, single-member LLC), you owe self-employment tax of 15.3% on net earnings — that's 12.4% Social Security + 2.9% Medicare, covering both the 'employer' and 'employee' halves you'd otherwise split. The good news: you deduct half (the 'employer half') as an adjustment to gross income on Schedule SE.

Social Security tax is 6.2% withheld from wages, up to the Social Security wage base ($184,500 for 2026). After you hit the cap mid-year (which happens in some high-earner months), 6.2% is no longer withheld. The employer pays an additional 6.2% match.

The aggregate method computes withholding as if the supplemental payment were spread across a regular pay period: take (salary + bonus), find the marginal rate that applies, and the difference vs. tax on salary alone is the bonus withholding. More accurate than flat-22% for high earners, often higher (closer to your real bracket).

The flat-rate method is the simpler option for employers — withhold 22% federal tax on the supplemental payment, period. Above $1M cumulative supplemental wages in a year, the rate jumps to 37%. It's predictable but under-withholds for anyone in the 24%, 32%, 35%, or 37% bracket — a common gotcha.

Supplemental wages are payments outside your regular salary: year-end bonuses, sign-on bonuses, severance, sales commissions, RSU vest income, NSO exercise spread, retroactive pay. The IRS lets employers withhold federal tax at a flat 22% (under $1M) or use the aggregate method (treating it as if added to a regular paycheck). State withholding follows separate state rules.

When you sell an asset, the capital gain = sale price − cost basis. Your basis is what you paid PLUS any amount already taxed as ordinary income. For RSU shares, basis = FMV at vest (the amount taxed on your W-2). For NSO shares, basis = strike + spread already taxed. Brokers often report a $0 basis on Form 1099-B because they only see the share transfer — you must adjust to avoid double-taxation. The single most common ISO/RSU/NSO mistake.

If you sell ISO shares before meeting the 2-year/1-year holding period, the disposition is 'disqualifying'. The spread (FMV at exercise − strike) is reclassified as ordinary income on your W-2 in the year of sale, and any post-exercise gain or loss becomes short-term or long-term capital. The benefit: this usually erases your AMT for the exercise year (since the same income is now in regular tax).

An Employee Stock Purchase Plan lets employees buy company stock at a discount (commonly 15% below fair market value) through post-tax payroll deductions over a 3–6 month offering period. Qualified ESPPs under IRC §423 add a 'lookback' that uses the lower of the offering-start price or purchase-date price. Tax treatment depends on holding period: if you hold shares 2+ years from offering start AND 1+ year from purchase date (qualifying disposition), the discount portion is taxed as ordinary income capped at the lesser of (offering-start FMV − purchase price) OR (sale price − purchase price); the rest is long-term capital gain. Disqualifying dispositions (selling earlier) push the entire discount + appreciation into ordinary income at the purchase date. ESPP is one of the most under-utilized employee benefits — the 15% discount alone is a guaranteed pre-tax return.

Fair Market Value is the IRS-recognized 'real' price of a share at a specific moment. For public companies, it's the closing market price. For private companies, it's the 409A valuation done by a third-party appraiser, refreshed annually or after material events. FMV at vest determines your RSU income; FMV at exercise determines your NSO/ISO spread.

Incentive Stock Options have unique tax treatment: at exercise, no regular income tax and no FICA. But the spread is an AMT preference item that can trigger Alternative Minimum Tax. If you hold for >2 years from grant AND >1 year from exercise (qualifying disposition), the entire gain on later sale qualifies for long-term capital gains rates. Sell early = disqualifying disposition: spread becomes ordinary income.

Non-qualified stock options give you the right to buy shares at a fixed strike price. When you exercise, the spread (FMV − strike) × shares is treated as ordinary W-2 wage income — taxed federal, FICA, state. NSOs are simpler than ISOs but worse tax-wise: no AMT preference, but no possibility of long-term capital gains on the spread itself.

A qualifying disposition is the holy grail for ISO holders. If you wait at least 2 years from the grant date AND 1 year from the exercise date before selling, the entire gain (spread + any post-exercise appreciation) gets long-term capital gains treatment (0/15/20% federal). The downside: you risk the stock dropping, and you pay AMT in the year of exercise.

RSUs are the most common equity-comp vehicle at large public tech companies. You're granted shares that vest on a schedule (typically 4 years, 25%/year, with a 1-year cliff). At each vest date, the fair market value of those shares becomes ordinary W-2 income — taxed federal, FICA, state. Most employers handle withholding by selling some of the vested shares (sell-to-cover).

When RSUs vest, the employer needs to withhold tax on the value. Most companies handle this via sell-to-cover: a portion of the vested shares is auto-sold at vest, and the proceeds pay the IRS / state. Default federal withholding is 22% (the supplemental flat rate). If your marginal rate is 32%/35%/37%, you'll owe more at filing — the 'sell-to-cover shortfall' that surprises many tech employees.

Strike price (also called exercise price) is the fixed price per share you pay to convert an option into actual shares. It's set at the FMV on the grant date and doesn't change. The spread (FMV at exercise − strike) is what matters tax-wise. NSO grants are typically priced at FMV; ISOs must be at FMV by IRS rule.

Vesting is the schedule that determines when grants become yours. The standard is 4 years with a 1-year cliff: nothing vests for the first year, then 25% vests at the 1-year mark, and the remaining 75% vests monthly or quarterly over the next 3 years. Leave before vesting and you forfeit the unvested portion.

AMT is a parallel federal tax system designed to limit how much certain taxpayers can reduce their bill via deductions and preferences. You compute your tax two ways — regular brackets and AMT — and pay whichever is HIGHER. The most common AMT trigger today is exercising Incentive Stock Options: the spread is an AMT preference item that doesn't appear in regular tax. AMT paid generates a credit you can use in future years.

The AMT crossover is the dollar amount of ISO spread (or other AMT preferences) you can take in a year before tentative minimum tax exceeds your regular tax — i.e., the largest exercise that keeps you AMT-free. Above the crossover, every additional dollar of spread costs you ~26-28% in AMT. Many advisors recommend exercising annually right up to the crossover to spread AMT risk over multiple years.

The AMT exemption is the chunk of AMTI that escapes AMT — like a standard deduction for AMT. For 2026: $90,100 single, $140,200 MFJ, $70,100 MFS. OBBBA 2025 dropped the phaseout thresholds and doubled the rate — exemption phases out at 50¢ per $1 of AMTI above $500,000 single / $1,000,000 MFJ, so the full exemption is gone by AMTI of about $680K single / $1.28M MFJ.

AMTI is the AMT version of taxable income. Start with regular taxable income, then add back items that AMT doesn't allow (state tax deduction beyond limits, certain depreciation differences) and add AMT preferences (ISO spread is the big one for tech employees). The AMT exemption is then subtracted from AMTI to get the amount actually taxed.

When you sell stocks, crypto, real estate, or other capital assets, the profit (sale proceeds − cost basis) is a capital gain. If negative, it's a capital loss. Hold for >1 year = long-term capital gain (preferential 0/15/20% federal rate). Hold for ≤1 year = short-term, taxed as ordinary income (10-37%).

Long-term capital gains are profits on assets held for more than one year. They get preferential federal tax rates — 0% if your taxable income is low (≤$48,350 single 2026), 15% in most middle brackets, 20% above $533,400 single. The hold-period rule is strict: 1 year + 1 day or more.

NIIT is an extra 3.8% federal tax on investment income (capital gains, dividends, interest, royalties, passive rental income), enacted as part of ACA in 2013. It kicks in if your MAGI exceeds $200,000 (single) or $250,000 (MFJ). The tax applies to the lesser of (a) all net investment income or (b) MAGI over the threshold. NIIT does NOT apply to wages, active business income, or distributions from qualified retirement accounts.

Section 1202 QSBS lets you exclude from federal tax up to $10M (or 10× your basis, whichever is greater) of capital gain on stock held 5+ years from a qualifying C-corp. The C-corp must have had <$50M in aggregate gross assets at the time the stock was issued. Per-issuer stacking via spousal grants and non-grantor trusts can shelter $20M-$60M+ at exit. Some states (CA, NJ, PA, MS, AL) do NOT conform — the federal $10M exclusion still applies but the state taxes the gain in full. The 5-year clock starts at exercise (or grant if 83(b) elected on restricted stock). The single largest wealth-build mechanic available to pre-IPO founders, early employees, and advisors with C-corp equity.

Section 121 of the Internal Revenue Code lets a homeowner exclude up to $250,000 (single) or $500,000 (married filing jointly) of capital gain on the sale of a primary residence — completely federal-tax-free. Eligibility: ownership AND use as primary residence for 2 of the most recent 5 years before sale. Most states conform. The structural late-career play: relocators who've owned a high-appreciated coastal CA / NY home for 15+ years can sell at retirement, capture $500K MFJ tax-free + relocate to a 0%-state-tax state. Combined with a domicile change, the move funds a substantial portion of the new house tax-free.

Short-term capital gains are profits on assets held one year or less. They're taxed as ordinary income at your marginal rate — up to 37% federal. The difference between short and long-term can be 15-20 percentage points, so timing matters: even one extra day past the 1-year mark can cut your tax bill significantly.

Head of Household is for unmarried (or 'considered unmarried') taxpayers who paid more than half the cost of maintaining a home for themselves and a qualifying child or relative who lived with them more than half the year. HOH gets wider tax brackets and a higher standard deduction ($22,500 in 2026) than Single — a significant tax break for single parents.

Married Filing Jointly is the default for most married couples. You combine income, deductions, and credits on one return — both spouses are jointly liable. MFJ tax brackets are roughly 2x the single brackets, so a single-earner couple usually saves significantly vs. filing single. Available even if one spouse has no income.

Married Filing Separately means each spouse files their own return with their own income, deductions, and credits. MFS brackets are roughly half of MFJ brackets, and several credits (Earned Income, Adoption, education) are unavailable. Used when separating tax liability is critical (one spouse has income-driven student loans, large medical deductions, or wants to wall off the other's potential issues).

Single is the default filing status for unmarried individuals who don't qualify as Head of Household. The 2026 standard deduction is $16,100. Single filers cross into higher brackets faster than MFJ — for example, the 32% bracket starts at $256,225 single but $512,450 MFJ.

The 401(k) is the default U.S. private-sector retirement vehicle. You contribute up to $24,500/year (2026 limit; $32,500 if age 50+) of pre-tax wages, and the contribution reduces your federal AND state taxable income immediately. Money grows tax-deferred; you pay tax when you withdraw in retirement (ideally at a lower bracket). Most employers match a percentage — typically 3-6%. The Roth 401(k) variant takes after-tax contributions but withdrawals are entirely tax-free.

The 403(b) is functionally identical to a 401(k) but offered by 501(c)(3) non-profits, public schools, and government employers. Same $24,500 elective deferral limit. Teachers, public hospital nurses, university faculty, and government employees use it. Many public-sector employers ALSO offer a 457(b), which can be stacked WITH the 403(b) for $47K/year combined pre-tax shelter — a uniquely powerful public-sector advantage that private-sector 401(k) holders don't get.

The 457(b) is a separate public-sector retirement plan that can be contributed to ALONGSIDE a 403(b) at the full $24,500 limit each — totaling $47,000/year of pre-tax retirement shelter. Private-sector employees with a 401(k) cannot do this. The 457(b) also has a unique 'special catch-up' rule: in the 3 years before normal retirement age, you can contribute up to 2× the annual limit if you have unused contribution room from prior years — a $141K window in your final 3 years pre-retirement. Almost no one uses this; ask HR.

A Flexible Spending Account is an employer-sponsored pre-tax account for qualified medical expenses (sometimes also dependent care via a separate Dependent Care FSA). 2026 limit: $3,400 for healthcare FSA, $5,000 for dependent care FSA. Key differences vs HSA: (1) FSA is use-it-or-lose-it — most plans require you to spend by year-end (some allow $660 carryover or 2.5-month grace period), (2) FSA funds can't be invested, (3) FSA is tied to your employer — leaving the job forfeits unused funds. FSAs work for everyone with employer-sponsored health insurance, while HSAs require an HDHP.

A High Deductible Health Plan is an IRS-defined category of health insurance that lets you contribute to an HSA. For 2026, the IRS minimums are: self-only deductible at least $1,650 (out-of-pocket max ≤$8,500), family deductible at least $3,300 (out-of-pocket max ≤$17,700). HDHPs typically have lower monthly premiums than traditional plans, with the trade-off being higher costs before insurance kicks in. The HSA tax shelter is what makes HDHPs strategically attractive — for healthy savers, the triple-tax-advantaged HSA can beat a Traditional IRA over decades.

HSA is structurally the most tax-advantaged account in U.S. tax law: pre-tax federal contribution, tax-free growth, tax-free withdrawals for qualified medical expenses. 2026 limits: $4,400 single / $8,750 family + $1,000 age-55+ catch-up. Requires enrollment in a qualifying high-deductible health plan (HDHP). After age 65, non-medical withdrawals are taxed as ordinary income (like an IRA) — making HSA effectively a stealth retirement account. California and New Jersey do NOT conform: HSA contributions are CA/NJ-state-taxable, and earnings are taxable annually at the state level. Federal benefits still outweigh the state hit, but plan around it.

Mega Backdoor Roth (MBR) is the highest-leverage tax-shelter move available to high-income tech employees. After maxing your standard $24,500 401(k), some employer plans allow up to ~$47,500 of additional after-tax contributions (with the IRS overall limit ~$72K total). If the plan also allows in-plan Roth conversion or in-service rollover to a Roth IRA, those after-tax dollars convert to Roth — tax-free growth, tax-free withdrawals for life. FAANG, most large tech, and many Fortune 500 plans support this. Confirm via your specific plan document — it's not universal.

NQDC plans (offered at most Fortune 500 and large finance firms for VP+ tier) let executives defer significant portions of base + bonus into multi-year payout ladders, typically 5-10 years out. The structural play: defer aggressively in your peak high-tax-state years, draw at 0%-state-tax retirement domicile (FL/TX/NV/TN). The structural risk: NQDC is an unsecured creditor claim against the employer — subordinate to bondholders in bankruptcy. Lehman 2008 employees forfeited billions in NQDC. Common practice is to cap NQDC deferral at 1-2× annual base.

The IRS requires Traditional IRA, 401(k), 403(b), and 457(b) account holders to begin taking Required Minimum Distributions (RMDs) at age 73 (raised from 72 by SECURE 2.0 in 2023). The annual amount is account balance / IRS Uniform Lifetime Table divisor (e.g., divisor 26.5 at age 73, dropping each year). Failure to take an RMD triggers a 25% excise tax on the shortfall (reduced from 50% by SECURE 2.0). Roth IRAs have NO lifetime RMDs (only inherited Roths from non-spouses). Roth 401(k) accounts had RMDs through 2023 but SECURE 2.0 §325 eliminated them effective 2024 — Roth 401(k) is now fully exempt during the original owner's lifetime.

The SECURE 2.0 Act of 2022 was the second major federal retirement reform after SECURE 1.0 (2019). Key provisions: (1) RMD age raised from 72 to 73 starting 2023, scheduled to rise to 75 in 2033; (2) Super catch-up contribution for 401(k) participants ages 60–63: $11,250 in 2026 instead of the standard $8,000 catch-up; (3) Roth 401(k) lifetime RMDs eliminated effective 2024 (§325); (4) RMD penalty cut from 50% to 25% (and to 10% if corrected promptly); (5) Mandatory automatic enrollment in new 401(k) plans (2025+); (6) Student loan match — employer 401(k) match can be tied to employee student loan payments; (7) Emergency savings linked to retirement plans (up to $2,500); (8) 529 → Roth IRA rollover after 15 years (with limits).

A SEP-IRA (Simplified Employee Pension IRA) is a retirement account for self-employed individuals and small business owners. Contributions are limited to the lesser of 25% of net self-employment income (after the SE-tax deduction) or $72,000 for 2026. SEP-IRAs are easier to administer than Solo 401(k)s — no 5500-EZ filing until $250K+ assets, no separate plan document required. The trade-off: SEP-IRA can't accept employee deferrals, so a sole proprietor with $50K of SE income can only contribute ~$10K to a SEP-IRA, while a Solo 401(k) at the same income level lets you defer $24,500 of the $50K plus the employer-side ~$10K = $33,500 total. SEP-IRA is best for higher-income sole proprietors who max out the 25% limit anyway, or business owners with employees (since SEP requires equal-percentage contributions for all eligible employees).

The Thrift Savings Plan is the federal government's defined-contribution retirement plan for civilian federal employees, members of the uniformed services, and ready-reserve forces. Same 2026 employee deferral limit as a private-sector 401(k) — $24,500, plus $7,500 age-50 catch-up and $11,250 super catch-up at ages 60–63. TSP offers both Traditional and Roth options. The biggest advantage: expense ratios around 0.04% — far below most private-sector 401(k) plans. TSP funds are limited (G, F, C, S, I funds plus Lifecycle target-date funds), but the cost advantage makes the simplicity worthwhile. Federal employees under FERS also get a 5% government match, comparable to a generous private 401(k).

The Fair Labor Standards Act (FLSA) is the 1938 federal law that establishes minimum wage and overtime pay rules. Workers are either FLSA-exempt (typically salaried professionals: lawyers, doctors, engineers, managers, executives) or FLSA-non-exempt / eligible (hourly workers, most trades, nurses, firefighters, police, truck drivers in interstate non-exempt categories). FLSA-eligible workers are entitled to time-and-a-half pay for hours beyond 40/week. The new federal OBBBA "No Tax on Overtime" deduction (2025-2028) applies only to FLSA-required overtime premium pay — knowing your FLSA status determines whether you can claim it.

Schedule K-1 is the IRS form that pass-through entities (partnerships, S-corps, LLCs taxed as partnerships, certain trusts) issue to each partner/shareholder/beneficiary reporting their share of income, deductions, and credits. The K-1 information flows to your personal return — different mechanics from W-2 wages. K-1 income from multi-state businesses requires state-by-state apportionment, which materially complicates the personal return. K-1 partnership income is generally subject to self-employment tax for active partners; K-1 S-corp distributions are NOT subject to SE tax. PE / hedge fund LPs receive K-1s for fund income.

PSLF forgives the remaining balance of federal Direct Loans after 120 qualifying monthly payments (10 years) while working full-time for a qualifying employer: 501(c)(3) non-profit, federal/state/local government, military, public school, or non-profit hospital. The forgiveness is tax-free at the federal level (some states tax it). Common uses: physicians at academic medical centers, teachers at public schools, lawyers at federal agencies or public defender's offices. Track via studentaid.gov; submit annual Employer Certification Form (ECF). Worth $200K-$500K to most academic-track professionals with significant student debt.

Section 199A's Qualified Business Income (QBI) deduction lets pass-through business owners deduct up to 20% of qualified business income from federal taxable income. For "specified service trades or businesses" (SSTBs) — medicine, law, accounting, consulting, finance — the deduction phases out above $276,775 single / $553,500 MFJ (2026 indexed thresholds) and is fully eliminated above. For non-SSTB businesses (manufacturing, real estate rental, software services), there's no income cap. California, New Jersey, and a few other states do NOT conform — federally-deducted QBI gets added back to state taxable income. The structural workaround for SSTB owners: separate non-SSTB rental / facility / equipment income that may preserve partial QBI.

An S-corp election (made by filing IRS Form 2553) converts a sole proprietorship or LLC into a pass-through corporation for tax purposes. The owner pays themselves a "reasonable" W-2 wage subject to FICA (15.3% combined Social Security + Medicare), then takes the remaining business income as an S-corp distribution NOT subject to FICA. At $400K+ net SE income, this typically saves $8K-$25K/year in self-employment tax. The IRS scrutinizes "reasonable comp" — typically 50-70% of net for service businesses. Some states (CA, NY) impose additional S-corp-specific taxes (CA $800 minimum franchise + 1.5% S-corp net income tax).

SSTB is the IRS designation that triggers the QBI deduction phase-out for high-income service-business owners. The list: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing, investment management, trading, dealing in securities/commodities, and any business where the principal asset is the reputation or skill of one or more employees/owners. Above $276,775 single / $553,500 MFJ (2026), QBI phases out for SSTB owners. Below those thresholds, SSTB owners get the full 20% QBI like everyone else. Architecture, engineering, real estate development, manufacturing, and software development are NOT SSTBs.