Most freelancers know about deductions for mileage, software, and a home office. Fewer know about the qualified business income (QBI) deduction, which can be bigger than all of those combined. It lets many owners of pass-through businesses, including sole proprietors and single-member LLCs, deduct up to 20% of their qualified business income.
Tax software usually applies it automatically, but knowing how it works helps you understand your tax bill and avoid decisions that accidentally shrink it.
Who can take it
The QBI deduction is available to owners of pass-through businesses: sole proprietorships, partnerships, S-corps, and LLCs taxed as any of those. W-2 wages from an employer do not count as qualified business income, and neither do things like capital gains or most interest income. You do not need to itemize to claim it.
What counts as qualified business income
QBI is generally your net profit from the business, reduced by certain related deductions, such as the deductible half of self-employment tax, self-employed health insurance, and contributions to a self-employed retirement plan. That is why the deduction usually comes out a bit smaller than a straight 20% of your Schedule C profit.
The overall cap
The deduction is also limited to 20% of your taxable income (before the QBI deduction) minus net capital gains. For someone whose income is mostly from their business and who takes the standard deduction, this cap can be the one that actually limits the deduction.
Where the limits kick in
Below an income threshold that is adjusted every year, most freelancers can take the full deduction with no extra conditions. Above that threshold, extra rules phase in.
- Specified service businesses, such as health, law, accounting, consulting, financial services, and businesses that rely on the skill or reputation of the owner, see the deduction phase out completely at higher incomes
- Other businesses become subject to a limit based on W-2 wages they pay and the property they own
- S-corp owners should note that their own salary is not QBI, so a higher salary reduces the deduction
How it interacts with other planning
Moves that lower your business profit, such as larger retirement contributions or electing S-corp status with a high salary, also lower your QBI deduction. That rarely makes them a bad idea, but it means the net savings are a little smaller than they first appear. Modeling the full picture, including QBI, before making a big change like an S-corp election gives you a more honest comparison.
This article is for general education only and is not tax or legal advice. Tax rules vary by jurisdiction, change over time, and depend on your specific situation. Talk to a qualified tax professional before making filing or payment decisions.