Tax Law Offers a Carrot to Gig Workers. But It May Have Costs.

The New York Times · by NOAM SCHEIBER · December 31, 2017

The tax bill signed by President Trump could let independent contractors like Uber drivers claim a 20 percent deduction on their earnings. But some labor advocates say the provision could ultimately hurt more workers than it helps. Sam Hodgson for The New York Times

The new tax law is likely to accelerate a hotly disputed trend in the American economy by rewarding workers who sever formal relationships with their employers and become contractors.

Management consultants may soon strike out on their own, and stockbrokers may hang out their own shingle.

More cable repairmen and delivery drivers, some of whom find work through gig economy apps like Uber, may also be lured into contracting arrangements.

That’s because a provision in the tax law allows sole proprietors — along with owners of partnerships or other so-called pass-through entities — to deduct 20 percent of their revenue from their taxable income.

The tax savings, which could be around $15,000 per year for many affluent couples, may prove enticing to workers. “If you’re above the median but not at the very, very top, one would think you’d be thinking it through,” said David Kamin, a professor of tax law at New York University.

The provision may also turn out to be a boon for employers who are trying to reduce their payroll costs. Workers hired as contractors, who tend to be cheaper, may be less likely to complain about their status under the new tax law.

“Firms currently have a lot of incentives to turn workers into independent contractors,” said Lawrence Katz, a labor economist at Harvard. “This reinforces the current trends.”

But it could lead to an erosion of the protections that have long been a cornerstone of full-time work.

Formal employment, after all, provides more than just income. Unlike independent contractors, employees have access to unemployment insurance if they lose their jobs and workers’ compensation if they are injured at work. They are protected by workplace anti-discrimination laws and have a federally backed right to form a union.

Those protections do not generally apply to contractors. Nor do minimum-wage and overtime laws.

“What you’re losing is the safety nets for those workers,” said Catherine Ruckelshaus of the National Employment Law Project, an advocacy group.

Traditional full-time jobs also insulate workers against the peaks and troughs in the demand for their services. Consider, for instance, the erratic income of retail or fulfillment-center workers hired in the fall and let go after the holidays.

Workers like janitors were once typically on the payrolls of large companies, enabling their wages to rise with those of other employees if the business did well. Now, such work is increasingly done by contractors. Lucy Nicholson/Reuters

And because companies have internal pay scales, the lowest-paid employees tend to make more than they would on the open market.

“It used to be that companies like G.M. or the local bank or factory directly employed the janitor, the clerical worker,” Professor Katz said, noting that their pay would rise along with other employees’ when the company was doing well.

Unwinding employment relationships eliminates these benefits, increasing the volatility of workers’ incomes and magnifying pay disparities and inequality.

It’s difficult to say how many workers would choose to become contractors as a result of the new provision, which for couples frequently begins to phase out at a taxable income above $315,000. Mr. Kamin said joint filers who make close to $315,000 and could transform most of these earnings into business income would find it most compelling to make the change. (It could be more compelling still if one spouse’s employer offered the couple health insurance, which many employers provide even though they aren’t required to.)

On the other hand, many individuals fail to avail themselves of existing tax deductions, like the one that freelancers can take for their expenses, said Jamil Poonja of Stride Health, which helps self-employed workers buy health insurance. That may reflect the lack of access among lower-earning workers to sophisticated tax advice.

The tax benefit could also be offset in some cases by the need for contractors to pay both the employer and employee portion of the federal payroll tax.

Many employers are already pushing the boundaries of who they treat as employees and who they treat as independent contractors.

In theory, it is the nature of the job, and not the employer’s whim, that is supposed to determine the worker’s job status.

If a company exerts sufficient control over workers by setting their schedules or how much they charge customers, and if workers largely depend on the company for their livelihood, the law typically considers those workers to be employees.

True contractors are supposed to retain control over most aspects of their job and can typically generate income through entrepreneurial skill, and not just by working longer hours.

In practice, however, many companies classify workers who are clearly employees as contractors, because they are usually much cheaper to use. And many labor advocates say the new tax deduction will encourage more employers to go that route by giving them an additional carrot to dangle in front of workers.

“The risk presented by this provision is that employers can go to workers and say, ‘You know what, your taxes will go down, let me classify you as an independent contractor,’” said Seth Harris, a deputy labor secretary under President Barack Obama.

Anything that makes workers more likely to accept such an arrangement makes it harder to root out violations of the law. That is because the agencies responsible for policing misclassification — the Labor Department, the Internal Revenue Service, state labor and tax authorities — lack the resources to identify more than a fraction of the violations on their own.

“Your chances of finding a worker that’s been misclassified if that worker has not complained are worse than your chances of finding a leprechaun riding a unicorn,” Mr. Harris said.

David Weil, the administrator of the Labor Department’s Wage and Hour Division under Mr. Obama, believes the change will add fuel to a trend that has been several decades in the making.

During that time, as Mr. Weil documented in a book on the subject, “The Fissured Workplace,” employers have steadily pushed more work outside their organizations, paring the number of people they employ and engaging a rising number of contractors, temporary workers and freelancers.

The tax law will accelerate the shift, he said, because employers who are already keen to reorganize in this way will recognize that even fewer workers are likely to object as a result of the tax benefits.

The effect of the deduction could be especially big in industries where misclassification is already rampant.

Many small-time construction contractors hire full-time workers who should be classified as employees but are kept on as freelancers or paid under the table, said Kyle Makarios, political director for the United Brotherhood of Carpenters and Joiners of America.

Mr. Makarios said the pass-through provision would encourage even more building contractors to misclassify workers, allowing them to reduce their labor costs and underbid contractors who play by the rules.

The practice by ride-hailing companies like Uber and Lyft of classifying drivers as independent contractors has long been criticized by labor advocates and plaintiffs’ lawyers. They argue that the companies control crucial features of the working relationship and hold most of the economic power.

Neil Bradley, senior vice president and chief policy officer at the U.S. Chamber of Commerce, said that gig-economy companies classify workers as contractors when it suits the needs of their business and that he did not expect that to change. He also said he did not expect firms with traditional business models to follow suit as a result of the new provision.

“I think the decision is going to be driven by the considerations” that lawyers cite, such as the amount of control a company exercises, he said, “not by this tax bill.”

But Mr. Weil was less sanguine.

“These kinds of approaches to making it easier to slide into independent contractor status reflect unequal bargaining power,” he said. “When you add to that an additional financial incentive, you’re just unwinding the whole system.”


The Winners and Losers in the Tax Bill

President Trump has called the $1.5 trillion tax cut that Republican lawmakers are on the verge of passing a Christmas present for the entire nation.

But the fine print reveals that some will get a much nicer gift than others, the benefits will change over time, and some will be left out in the cold. Real estate developers and technology companies could see big tax cuts, while low-income households and people buying health insurance could lose out.

With the bill finally headed to a vote this coming week, taxpayers are scrambling to determine whether the legislation renders them winners or losers.

WINNERS

PRESIDENT TRUMP AND HIS FAMILY Numerous industries will benefit from the Republican tax overhaul, but perhaps none as dramatically as the industry where Mr. Trump earned his riches: commercial real estate. Mr. Trump, along with his son-in-law Jared Kushner, who is part owner of his own real estate firm, will benefit from lower taxes on so-called “pass through” income, which is money earned by partnerships and other types of businesses whose income is passed through to its owner and taxed at the individual tax rate. Mr. Trump and Mr. Kushner benefit since they own properties through limited liability companies and other similar vehicles.

Under current law, that income is taxed at rates as high as 39.6 percent. Under the bill, much of that income could be taxed at a rate as low as 29.6 percent, subject to some limitations. Real estate also avoided new limits on interest deductions and retained its ability to defer taxes on the exchange of similar kinds of properties. The benefits of lower rates on pass-through income will extend to Mr. Trump and Mr. Kushner’s partners at real estate investment trusts as well. At the last minute, lawmakers added language to make it easier for real estate owners to avoid some of the pass-through provision’s restrictions and maximize the tax benefits even more.

BIG CORPORATIONS Industries like big retailers will benefit from the new corporate rate of 21 percent, since those companies pay relatively close to the full 35 percent rate. Other aspects of the corporate tax cuts will be enjoyed by an array of multinational industries, particularly technology and pharmaceutical companies, like Google, Facebook, Apple, Johnson & Johnson and Pfizer. Such multinational companies have accumulated nearly $3 trillion offshore, mostly in tax haven subsidiaries, untouched by the United States taxman. The tax bill will force those companies to gradually bring that money home, but it will be taxed at rates ranging from 8 percent to 15.5 percent. That’s far lower than the current 35 percent tax rate on corporate profits and even lower than the new 21 percent rate.

Plus, American companies will no longer owe full corporate taxes on future profits they say they earn abroad, providing more incentive to push income into tax haven subsidiaries. The law even includes provisions that could encourage companies to move workers abroad, despite pledges to do the opposite.
 

MULTIMILLIONAIRES An exemption for estates that owe what Republicans call the “death tax” was lifted to $22 million from $11 million. That doesn’t matter much to billionaires like Charles Koch, but means a big tax cut for people with estates worth tens of millions of dollars.

Plus, the top rate applying to wages and interest income would be cut to 37 percent from 39.6 percent.

PRIVATE EQUITY MANAGERS During the campaign, Donald Trump railed against wealthy investment managers who, thanks to the so-called carried interest loophole, pay taxes on the majority of their pay at a lower capital gains rates. But the purported reform to this tax provision will affect few if any private equity managers, leaving the loophole intact.

PRIVATE SCHOOLS AND THE PEOPLE WHO CAN AFFORD THEM Parents would be eligible to use a type of tax-preferred savings plan — known as a 529 plan — to save for their children’s elementary and secondary education. Right now, those savings plans are only eligible for college. But they would be expanded to allow for up to $10,000 a year for tuition at private and religious schools.

THE LIQUOR BUSINESS Excise taxes for small brewers and distillers are reduced in the final agreement. Those industries are dominated by entrepreneurial small businesses often based in rural areas. They also have strong lobbyists, and many are based in states with powerful senators, like Senator Rob Portman of Ohio. Mr. Portman, who tucked a provision to help craft brewers into the Senate legislation, was part of the small team of lawmakers who merged the two bills into a final version.

ARCHITECTS AND ENGINEERS They were originally restricted in how much they could benefit from the new pass-through provision. If they structure their businesses a certain way, the final version will let them benefit fully.

TAX ACCOUNTANTS AND LAWYERS Mr. Trump once said his “dream” was to put tax preparation services out of business by simplifying the tax code. But the rushed legislation will probably have the opposite effect, as individuals try and make sense of the complicated new provisions, staggered dates and new rates. The uncertainty and confusion will probably create numerous new opportunities to game the system: tax preparers are sure to see a boom in business advising clients on how to restructure their employment and compensation arrangements to take advantage of the lower tax rates on income reported by corporations and pass-through entities.

 

LOSERS

PEOPLE BUYING HEALTH INSURANCE With the repeal of the individual mandate, some people who currently buy health insurance because they are required by law to do so are expected to go without coverage. According to the Congressional Budget Office, healthier people are more likely to drop their insurance, leaving insurers stuck with more people who are older and ailing. This is expected to make average insurance premiums on the individual market go up by about 10 percent. All told, 13 million fewer Americans are projected to have health coverage, according to the Congressional Budget Office.

INDIVIDUAL TAXPAYERS IN THE FUTURE To stay under the $1.5 trillion limit for new deficits lawmakers set for themselves, they opted to make the cuts for individuals and families temporary, expiring at the end of 2025 — even as the corporate tax cuts will be permanent. Republicans are counting on a future Congress to extend the lower rates, as has happened in the past. But there are no guarantees, and that could mean a big tax increase down the road. What is more, the use of a different, less generous measure of inflation would push taxpayers into higher tax brackets more quickly.

THE ELDERLY A 2010 law requires that any legislation that adds to the federal deficit be paid for by spending cuts, increases in revenue or other offsets. Some cuts would be automatic, and the biggest program to be affected is Medicare, the health insurance program for the elderly and disabled. Dozens of other programs are likely to be cut as well, but Medicare, which would face a 4 percent cut, is by far the biggest. Republicans say that this rule will be waived and the cuts will be averted, but that will take a bipartisan deal.

LOW-INCOME FAMILIES Low-income families who claim the earned-income tax credit will lose out on at least $19 billion over the coming decade under the bill because of the change in the way inflation is calculated. And a new requirement that families claiming the child tax credit provide a Social Security number is projected to mean a big reduction in the families claiming it, since those who are not in the United States legally would be prohibited, even if their children were born in the United States.

OWNERS OF HIGH-END HOMES Under current law, the interest on mortgages for first and second homes is deductible for the first $1 million of the loan. The overhaul would cut that to the first $750,000 and eliminate the owner’s ability in the current law to deduct the interest on a home-equity loan up to $100,000. This could drive down home prices in some high-end markets; good for prospective buyers but bad for prospective sellers.

PEOPLE IN HIGH PROPERTY TAX, HIGH INCOME STATES Homeowners in high-tax states like New York, New Jersey and California could be big losers, particularly if they have high property taxes. Their ability to deduct their local property taxes and state and local income taxes from their federal tax bills is now capped at $10,000. In some cases, that could be offset by the lower tax rates that all taxpayers will owe on their ordinary income.

 

THE INTERNAL REVENUE SERVICE The tax collection agency has been underfunded and understaffed for years. Now, it will have a raft of new tax rules to deal with that will require upgrading its software, printing new manuals and explaining to confused taxpayers how things work. All this is expected to take place while the commission is working under the supervision of an interim commissioner, who is expected to be replaced sometime next year.


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