A provision in the new tax law allows sole proprietors — along with owners of partnerships or other pass-through entities — to deduct 20 percent of their revenue from their taxable income.
The new tax law is likely to accelerate a hotly disputed trend in the U.S. economy by rewarding workers who sever formal relationships with their employers and become contractors.
Management consultants soon may 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 pass-through entities — to deduct 20 percent of their revenue from their taxable income.
Most Read Business Stories
- REI keeps stores shut and furloughs many of its workers for 90 days; CEO gives up pay for six months
- Seattle area's March home prices jumped, before coronavirus pandemic took hold
- Seattle-area small businesses applying for federal coronavirus loans see potential and problems
- Grocery workers are dying of coronavirus
- Boeing urged by Washington's congressional delegation to take bailout money, pay workers
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.
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 GM or the local bank or factory directly employed the janitor, the clerical worker,” 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.
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 IRS, 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,” Harris said.