When IRC sections collide: What are "W-2 wages" when calculating QBID?

A recent Tax Court case involves an interesting interaction between the § 199A qualified business income deduction and § 280A disallowance of expenses in drug trafficking businesses

I’m researching the IRC § 199A qualified business income deduction for some upcoming teaching engagements, and I came across an interesting recent Tax Court case: Savage v. Comm. and Torres v. Comm., 165 TC 5 (2025).

Section 199A allows a deduction for taxpayers of up to 20% of qualified business income (QBI) from passthrough entities. The Petitioners co-owned three cannabis businesses taxed as S corporations. This case involves two of them and hinges on whether a cannabis business subject to § 280E can use the total W-2 wages paid, or only the deductible portion of those wages paid, for the calculation of the § 199A qualified business income deduction (QBID).

In calculating their § 199A deductions, the Petitioners used total W-2 wages paid by the two businesses to determine their QBID. The IRS disagreed, arguing that W-2 wages nondeductible under § 280E cannot be considered under § 199A.

In the majority opinion, agreeing with the IRS, Judge Toro writes that Congress provides an exception to the general rule that a taxpayer uses total W-2 wages paid for the calculation. Section 199A(b)(4)(B) states that, for purposes of the section, the “term [W-2 wages] shall not include any amount which is not properly allocable to qualified business income…” (emphasis added).

The Court then examines the meaning of “properly allocable,” connecting it to the statutory definition of QBI in § 199A(c). Section 199A(c)(3)(A)(ii) limits the definition of QBI to items “included or allowed in determining taxable income for the taxable year.” The Court works backward to decide that, because § 280E makes a portion of the W-2 wages nondeductible, then that portion does not qualify for inclusion in the definition of QBI and therefore cannot be used in the calculation of the deduction.

In a dissent, Judge Jenkins considers the policy intent of § 199A, which was to encourage the creation of jobs for Americans. Also, Congress did not include drug trafficking businesses in its list of ineligible trades or businesses in § 199A(d).

It’s an interesting case for a few reasons: first, it shows how different sections of the IRC can interact in unexpected ways; second, Jenkins’ dissent highlights the contention between desired policy outcomes and strict interpretations of the law; and third, it is the sole significant discussion of § 199A I can find in a court case.

NB The Petitioners have filed an appeal in the 9th Circuit.

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I’m recording an upcoming episode of Tax in Action on QBID. I’m also teaching a 2 CE course on QBID at the National Association of Enrolled Agents 2026 Tax Summit. (Let me know if you’re attending!)

If you have questions about QBID, let me know by posting a comment here!

Do you agree with Toro’s opinion? Or does Jenkins’ dissent make more sense? Let me know!

I’ll also discuss QBID in my three-hour practical, hands-on workshop on S corporations at the New York State Society of Enrolled Agents Annual Conference in October.