For freelancers, LLC and S corporation owners, and partners in pass-through businesses in the United States, the qualified business income (QBI) deduction under Section 199A, which removes 20% of business income from taxable income, is one of the most valuable provisions in the tax code. Introduced as a temporary measure in the 2017 tax law, it was made permanent by the OBBBA in 2025, and the income limitation rules were relaxed starting in 2026. This article explains how the deduction is computed, which income qualifies and which does not, the 2026 threshold amounts and the treatment of specified service businesses, what the OBBBA changed, and the points Japanese business owners most often miss. Rules are as of 2026.
The Basics: A 20% Deduction for Business Income
The QBI deduction allows an individual to deduct 20% of qualified business income from pass-through businesses (sole proprietorships reported on Schedule C, partnerships, S corporations, and rental real estate that rises to the level of a trade or business). It is available whether you take the standard deduction or itemize. The deduction equals the lesser of:
- 20% of QBI (plus 20% of qualified REIT dividends and publicly traded partnership income), or
- 20% of taxable income (before the QBI deduction) minus net capital gain.
For example, a freelancer with $80,000 of net profit, no other income, and taxable income of $60,000 after the standard deduction is limited to $60,000 x 20% = $12,000, not $16,000. The deduction is claimed on Form 8995 (simplified) or Form 8995-A and does not apply to C corporation income or wages.
What is not QBI
- Wages earned as an employee, reasonable compensation an S corporation owner pays himself or herself, and guaranteed payments to partners.
- Capital gains and losses, dividends, and interest not connected to the business.
- Income from business activities conducted outside the United States. QBI is limited to income effectively connected with a U.S. trade or business, so fees for work performed in Japan do not qualify.
- QBI must also be reduced by the deductible half of self-employment tax, the self-employed health insurance deduction, and contributions to SEP, Solo 401(k), and similar plans.
Income Limitations: 2026 Thresholds and the Phase-In
If your taxable income before the QBI deduction is at or below the threshold, the full 20% deduction is available regardless of the type of business. For 2026 the thresholds are $201,750 for single filers and $403,500 for joint filers. Above the threshold, two limitations phase in. The OBBBA widened the phase-in range from $50,000 / $100,000 to $75,000 / $150,000 starting in 2026, so the limitations apply in full at $276,750 (single) and $553,500 (joint).
| Type of business | At or below threshold (2026: $201,750 single / $403,500 joint) | Within the phase-in range | Above the range ($276,750 single / $553,500 joint) |
|---|---|---|---|
| Ordinary business | 20% of QBI | W-2 wage and property (UBIA) limitation phases in | Deduction capped at the greater of 50% of W-2 wages, or 25% of wages plus 2.5% of the unadjusted basis of qualified property |
| Specified service trade or business (SSTB) | 20% of QBI | Deduction phases down | No deduction |
What counts as a specified service business
Health, law, accounting, consulting, financial services, investment management, performing arts, athletics, brokerage services, and any business whose principal asset is the reputation or skill of its owners or employees are specified service trades or businesses (SSTBs). Above the threshold the deduction shrinks and disappears at the top of the range. Independent accountants, lawyers, and consultants of Japanese background are directly affected. Engineering and architecture are specifically excluded from the SSTB definition.
What the OBBBA Changed
- Permanence: the deduction, which was scheduled to expire after 2025, is now permanent.
- Wider phase-in range: $75,000 single / $150,000 joint from 2026, indexed thereafter, which helps SSTB owners whose income modestly exceeds the threshold.
- New minimum deduction: taxpayers with at least $1,000 of QBI from active businesses in which they materially participate receive a minimum deduction of $400 even if the regular computation yields less (from 2026, indexed).
- The 20% deduction for qualified REIT dividends and publicly traded partnership income is also permanent.
Points Japanese Owners Often Miss
- S corporation salary: owners are tempted to keep salary low to save self-employment tax, but salary is excluded from QBI while it helps the W-2 wage limitation. Above the threshold, the salary level needs to be designed with both effects in mind.
- Rental real estate: the question is whether the rental rises to a trade or business. The safe harbor in Rev. Proc. 2019-38, which requires among other things 250 hours of rental services per year, allows qualifying rentals to be treated as businesses. Pure triple net leases generally do not qualify.
- Nonresidents: a person living in Japan who conducts a U.S. business and reports effectively connected income can consider the QBI deduction on Form 1040-NR, but income from services performed outside the U.S. is excluded.
- Aggregation: businesses under common control can be aggregated to compute the W-2 wage limitation more favorably. Once elected, aggregation generally must be continued.
- State tax: most states do not allow the QBI deduction in computing state taxable income, so do not expect the federal saving to carry over.
Frequently Asked Questions
My side freelance income is small. Can I still use the deduction?
Yes. If you have Schedule C profit alongside your salary, you can deduct 20% of it, subject to the 20% of taxable income cap. From 2026, if you have at least $1,000 of QBI from a business in which you materially participate, you are guaranteed at least a $400 deduction.
I am a consultant and my income exceeded $300,000. Is my deduction zero?
Consulting is an SSTB, so a single filer with taxable income above $276,750 (2026) gets no deduction. A joint filer with taxable income below $553,500 may retain a partial deduction. Retirement plan contributions and other steps that bring taxable income closer to the threshold can be effective.
Do fees for work I performed in Japan for Japanese clients count as QBI?
No. QBI is limited to income effectively connected with a U.S. trade or business. A U.S. resident must report the Japanese fees as part of worldwide income, but they are excluded from the QBI computation.
This article is provided for general informational purposes only and does not constitute individual tax advice. Please review current IRS rules and consult a qualified U.S. tax professional before acting.
Summary
The QBI deduction removes 20% of pass-through business income from taxable income, is now permanent under the OBBBA, and from 2026 comes with a wider phase-in range and a $400 minimum deduction. Below the 2026 thresholds ($201,750 single, $403,500 joint) it applies to any type of business; above them, the W-2 wage limitation and the SSTB rules take over. Balancing salary and distributions, meeting the rental safe harbor, excluding non-U.S. income, and remembering that most states do not conform are the keys to capturing the full benefit, along with year-end planning that keeps taxable income near the threshold.
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