Small Business Tax Deduction Faces Hard $25K Cap and $200K Income Phase-Out Starting in 2026

The bill, officially dubbed the “Mom and Pop Tax Relief Act,” takes aim at the Section 199A deduction—the one that lets certain small businesses deduct up to 20% of their qualified business income. While the name suggests broad relief, the actual text introduces some serious constraints that will change how many small business owners calculate their taxes starting in 2026.

The New Ceiling: Why Size Matters

Currently, the 199A deduction is based on a percentage of your business income, which means the more you earn, the bigger the potential deduction. This bill changes that by imposing a hard cap on the income eligible for the calculation. Specifically, you can only count up to $25,000 of your qualified business income toward the deduction, even if your business earned far more. For the successful single-owner contractor or the profitable local bakery that nets $100,000 in qualified business income, this change means a significant chunk of their income is now ineligible for the deduction. The benefit is essentially capped, limiting the upside for growing small businesses.

The Income Cliff: Hitting the $200K Mark

If you’re a small business owner with a higher household income, the bill adds a second layer of complexity. If your Adjusted Gross Income (AGI) exceeds $200,000, the amount you can count toward the deduction starts to shrink. It’s a dollar-for-dollar reduction, meaning if your AGI is $210,000, that extra $10,000 over the threshold eats away at your potential deduction base. This aggressive phase-out means that many middle-to-upper-middle-income professionals—think successful consultants, specialized trade workers, or small firm partners—will see their 199A benefit disappear entirely, even if their qualified business income is below the $25,000 cap.

Tightening the Definition of Wages and Business

Beyond the caps, the bill tightens up the rules on what counts as a “qualified trade or business” and which wages are eligible for the calculation. First, it explicitly clarifies that income earned as an employee doesn’t count for this deduction—a necessary cleanup of the tax code. More importantly for businesses with employees, the definition of "W-2 wages" is getting stricter. Those wages must now be properly connected to your domestic production gross receipts and, critically, must be reported to the Social Security Administration within 60 days after the original due date of the return. If your payroll filing is even slightly late, those wages could be disqualified from the calculation, which could be a real headache for small firms dealing with administrative delays.

The Real-World Impact

This legislation essentially shifts the focus of the 199A deduction. For the smallest businesses with AGIs under $200,000 and qualified income below $25,000, the impact is minimal, and they might benefit from the clearer definitions. However, for the successful, growing small business—the one that’s hiring and expanding—this bill acts as a ceiling. A profitable owner who nets $250,000 a year will likely see their entire 199A deduction vanish due to the AGI phase-out, even though they technically run a qualified business. The bill also tasks the Treasury Secretary with issuing guidance on complex accounting situations, like short tax years or when a business is bought or sold, which should help clarify compliance for those specific, complicated transactions.