Like many pieces of complex legislation, the newly passed tax law is proving to generate as much confusion as clarity. This is especially true when it comes to the effects the new legislation will have on the gig economy. Along with the rest of the country, we’re taking time to sift through the language of the new law to understand the implications for workforce planning and management. One facet of the law garnering some attention is the increase in deductions allowed via so-called “pass-through” business entities. Here’s some insight into how and why this one facet of the law is predicted to have significant impact on independent contractors and the broader gig economy.
A provision in the new law permits sole proprietors (many of which are independent contractors and freelancers) and LLPs to deduct a full 20% of their revenue from their top line, taxable income. Many tax analysts are suggesting that this larger deduction may entice more wage earners to strike out on their own, as greater number of workers decide to become ICs in order to take advantage of the generous deduction. In addition, employers who have been focused on reducing payroll benefit costs, are expected to encourage this trend by hiring more contractors and fewer FTEs. Taken together, this one-two punch does seem to suggest the law will incentivize greater numbers of Americans to become contractors.
If this trend does materialize however, it could represent something of a new risk for organizations with respect to increased potential for costly IC classification headaches. This is because it could lead to higher levels of abuse of IC labor by organizations eager to slim down their payroll costs and willing to play a bit faster and looser with the rules. The agencies responsible for policing misclassification (the Department of Labor, the IRS and state tax/labor agencies) will likely experience a greater volume of IC activity without any corresponding increase in the budgets they’re allotted to investigate and prosecute misclassification. As a result, levels of misclassification are likely to rise, and although enforcement may struggle to keep pace, overall, the number of IC misclassification inquiries will indeed rise accordingly.
The new law does include some exceptions designed to reduce or prevent abuse of the new pass-through allowance. It excludes the pass-through benefit for the performance of services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting athletics, financial services, brokerage services, or any trade where the principal asset of such business is the reputation or skill of one or more of its employees. For contractors in these fields, the 20% pass-through deduction is limited to either 50% of W-2 wages paid by the business or 25% of W-2 wages plus 2.5% of the tax basis of the qualified property owned by the business, whichever is greater. In short, companies and contractors whose business involves services rather than capital-based labor generally don’t stand to gain any deduction.
Touted as a simplification of the tax code, it would seem, for ICs/gig workers and employers alike, this new law will complicate both classification and tax calculation. It remains to be seen what effect the new, hurriedly-written legislation will ultimately have on workforce planning and management. With each passing day, more analysis is released from tax and policy experts. There is certainly a good deal more to be understood about the law’s consequences.
Stay tuned to the nextSource blog where we will be providing ongoing coverage and analysis of this very fluid situation. If you wish to stay ahead of the curve with respect to the ramifications for your workforce planning and management initiatives, you’d be well-advised to reach out to your nextSource representative to discuss the law’s impact on your specific business operations.