Originally published on Forbes.com.
The Tax Cuts And Jobs Acts being considered in the Senate seems to have more about jobs than the House bill . The stark contrast is most apparent when you compare Section 1004 of the House bill – Maximum rate on business income of individuals – with the comparable provision in the Senate bill – Allow 17.4-percent deduction to certain pass-through income. The actual provisions of the Senate proposal arguably encourage jobs, while the house proposal encourages replacing workers with robots. Here is how that works.
The Senate 17.4% Deduction Versus The House 25% Rate
The deduction proposed in the Senate bill would be 17.4% of “domestic qualified business income from a partnership, S corporation, or sole proprietorship”. Like the House bill’s special rate the deduction is not allowed for “specified service businesses” (Physicians and accountants, for example). There is an exception to that rule for taxpayers with taxable income of less than $150,000 (Joint return). For them the benefit is phased out over a $50,000 range. The big contrast there with the House special rate is that the House provision does not provide any benefit to anyone with taxable income of less than $260,000 (Joint return). But what about jobs?
The Senate bill provides that in the case of a flow-through from a partnership or an S corporation the deduction is limited to 50% of the W-2 wages paid by the entity.(There was a similar rule with respect to the domestic production deduction which both bills slate for repeal). So to make up an example, Wade Gustafson owns a grocery chain that he does not work in. He has a flow-through profit of $2,000,000. Wade will get a deduction of $348,000. But to get the full deduction he needs his S corporation to be paying at least $696,000 in W-2 wages. So perhaps a proposal to convert even more of the cash registers to self-service might seem a little less attractive. Under the House bill, Wade would get the favorable 25% on the whole $2,000,000 even if the stores were run entirely by robots.
Change the facts a little and have Wade working in the chain taking a reasonable salary of $300,000 which leaves him with a flow-through profit of $1,700,000. We don’t have the statutory language on the Senate version yet, so I don’t know if the $3oo,000 Wade is drawing counts toward his W-2 limit. Regardless, he gets a free deduction of $295,800 if he has W-2 wages of $591,600 leaving it open for now whether his own salary counts toward that. Under the House bill, Wade will get the special 25% rate on $600,000 of his income, using the default 70/30 rule in the provision. I make the Senate bill about $30,000 better for Wade under that scenario but wait. If Wade spends lavishly on capital items he can move the capital income ratio. My back of the envelope computation is that Wade will reclassify $80,000 of income into being subject to the preferred rate for every million dollars that he goes over $7,500,000 in capital assets.
So under the Senate bill there is an incentive to pay wages and under the House bill there can be an incentive to automate. Frankly, my advice would probably be to not respond to either incentive and just make the best business decision, but that’s just me.
But What Is A Job?
I remember once having a discussion with a real estate developer. He started talking about what a jobs creator he was, implying that it is better for the world if he pays less in taxes. I challenged him noting that he had hardly anybody on his payroll. He then kind of passionately laid into me and I quickly admitted my error. His projects made work for lots of people that were not on his payroll.
Nonetheless, are gig creators job creators? Back in the day, when it was plausible that one of the required courses for my degree in Business Administration/Accounting was titled Social Responsibility of American Business, one might think that you would only consider something a real job if it allowed someone some degree of certainity that they could show up every week and perform regular duties and be able to support a family and have some level of security. The post World War II economy that supporters of both Bernie Sanders and Donald Trump pine for had something of a pact between labor and the business community. That pact was burned on the altar of shareholder value beginning in the seventies. Management was no longer accountable to a number of stakeholders, but rather to one – stock price.
Well, I leave as an open question whether the gig economy means the end of jobs, but I will note that the Senate bill having the 17.4% only going to businesses with W-2 wages is a nod in the favor of traditional jobs. On the other hand, other provisions of the Senate bill are promoting the gig economy.
How The Senate Bill Leans Toward Gigs
The 17.4% deduction while encouraging W-2 wages to some extent also pushes toward gigs. I really hope to see the statutory language soon, but apparently the W-2 requirement only applies to partnerships and S corporations. And remember it applies to everybody with taxable income below $150,000 on a joint return and $75,000 on a single return. That creates a strong incentive on the employee side to prefer a position as an independent contractor. But that’s not all.
The Senate bill also has the section called – Determination of Worker Classification and Information Reporting Requirements. The provision creates a “safe harbor’ that will allow companies to feel more secure in treating workers as independent contractors.
In order for this treatment to apply to service, in connection with performing the service, the service provider generally must (1) incur expenses which are deductible as trade or business expenses and a significant portion of which are reimbursed; (2) agree to perform the service for a particular amount of time, to achieve a specific result, or to complete a specific task; (3) have a significant investment in assets or training applicable to the service performed, not be required to perform services exclusively for the service recipient, have not performed substantially the same services for the service recipient or payor as an employee during the one-year period ending with the date of commencement of services under a contract meeting the requirements described below, or not be compensated on a basis which is tied primarily to the number of hours actually worked. (Emphasis added)
It seems to me that “or” is the keyword there. Meeting all of those criteria would not leave much doubt that someone was a contractor under current law, but only having to meet one is not that big a deal.
Summary
The House Tax Cuts and Jobs bill does not seem to address jobs at all. A small exception to that would be that the maximum rate seems to encourage family businesses to hire outsiders to run them since the family members who work in the business will not get as favorable tax treatment. The Senate bill does have an explicit limitation on the deduction that it creates instead of a special rate that encourages having some employees. On the other hand, both the special deduction and the safe harbor provision seem to point toward moving further toward the gig economy.
Other Coverage
Shy-Yi Oei and Diane M. Ring have The Senate Tax Bill And The Battles Over Worker Classification. Their concern is that tax clarification will have a variety of other consequences stripping workers of the protections that existed in the traditional employer-employee relationship.
Workplace ProfBlog has a post titled Republican Tax Bill Puts Thumb on EE-IC Scale which summarizes the Tax Prof post. Diane Ring has a good summary on
Small Business Labs has Proposed Senate Tax Bill Would Change Gig Worker Classification and the Gig Economy.
Erik Sherman on forbes.com has Tax Bill Could Increase Worker Status As Contractors, Decrease Benefits And Protections.
My tendency is to think that the traditional employer-employee relationship, much as I might mourn it, is doomed. Arguably, its origin in the laws about masters and servants might mean that it will ultimately not be missed. The dystopian nightmare would be that as inequality explodes, some form of indentured servitude will be instituted for people without property. If you want to be really disturbed read Cannibals All! Or, Slaves without Masters by George Fitzhugh which was published in 1857.
What is falsely called Free Society, is a very recent invention. It proposes to make the weak, ignorant and poor, free, by turning them loose in a world owned exclusively by the few (whom nature and education have made strong, and whom property has made stronger,) to get a living. In the fanciful state of nature, where property is unappropriated, the strong have no weapons but superior physical and mental power with which to oppress the weak. Their power of oppression is increased a thousand fold, when they become the exclusive owners of the earth and all the things thereon. They are masters without the obligations of masters, and the poor are slaves without the rights of slaves.
Not directly relevant to the bill, but still of interest, Kathleen Delaney Thomas of the University of North Carolina School of Law has a paper on Taxing the Gig Economy.