Shu-Yi Oei (Boston College) & Diane M. Ring (Boston College), The Senate Tax Bill and the Battles over Worker Classification:
Senate Republicans released their version of tax reform legislation on Thursday, November 9. The legislative language is not available yet, but the Description of the Chairman’s Mark (prepared by the Joint Committee on Taxation) suggests that one of the key provisions in the bill will clarify the treatment of workers as independent contractors by providing a safe harbor that guarantees such treatment. The JCT-prepared description tracks the contents of the so-called “NEW GIG Act” proposed legislations introduced by Congressman Tom Rice (R-S.C.) in the House and Senator John Thune (R-S.D.) in the Senate in October and July 2017, respectively. “NEW GIG” is short for the “New Economy Works to Guarantee Independence and Growth (NEW GIG) Act.” But notably, and as we further discuss below, the legislation is not limited in its application to gig or sharing economy workers.
Assuming the Senate Bill adopts the basic parameters of the NEW GIG proposed legislation — which looks to be the case based on the JCT-prepared description — we have some concerns. In brief, this legislation purports to simply “clarify” the treatment of workers as independent contractors and to make life easier for workers by introducing a new 1099 reporting threshold and a new withholding obligation. But the legislation carries potentially important ramifications for broader fights over worker classification that are raging in the labor and employment law area. Despite possibly alleviating tax-related confusion and reducing the likelihood of under-withholding, we worry that there are quite a few underappreciated non-tax hazards for workers if these provisions go through.
Summary of the Legislation
The legislation (assuming the Senate Bill more or less tracks the NEW GIG Act language) purports to achieve such “clarification” of worker classification status by doing the following:
First, the legislation introduces a safe harbor “which, if satisfied, would ensure that the worker (service provider) would be treated as an independent contractor, not an employee, and the service recipient (customer) would not be treated as the employer.” The legislation creates three objective tests, which, if met, ensure that the worker would be treated as an independent contractor rather than an employee. Very generally, those tests focus on (1) the relationship between the parties (including specificity of the task, exclusivity of the relationship, and whether the service provider incurs their own expenses), (2) the location of services or means by which they are provided, and (3) the existence of a written contract stating the independent-contractor relationship and acknowledging responsibility for taxes and a reporting/withholding obligation. (See JCT-prepared Description pp. 155-57.)
The first two tests are pretty easy for any sharing economy business to meet. In fact, many non-sharing businesses, such as those contracting with a broad swath of freelancers, could satisfy the safe harbor requirements, thereby extending the true reach of the legislation well beyond the gig economy. The “written contract” test is also not onerous. That requirement is essentially met if there is a written contract that makes the right noises in which the parties agree to independent contractor treatment. (Unsurprisingly, a contractual limitation is often not really a limitation at all.)
Second, the legislation clarifies the information reporting rules: It establishes a $1,000 threshold for Form 1099-K reporting and raises the 1099-MISC threshold from $600 to $1,000. (Under current law, there is some question of whether a Form 1099-K needs to be provided if the transactions do not exceed $20,000 and more than 200 transactions. We detail this issue in our article, “Can Sharing Be Taxed?”.)
Third, the legislation also requires the service recipient/payor to withhold limited amounts on payments made to independent contractor workers covered by the safe harbor. From the JCT-prepared description: “The proposal imposes an income tax withholding requirement with respect to compensation paid pursuant to a contract between a service provider and a service recipient (or payer) that meets the [safe harbor] requirements. For this purpose, a payment of such compensation is treated as a payment of wages by an employer to an employee. However, the amount required to be withheld is five percent of the compensation and only on compensation up to $20,000 paid pursuant to the contract.”
Fourth, the legislation limits the IRS’s ability to reclassify service providers as employees (and service recipients/payors as employers) in cases where the parties try in good faith to comply with the safe harbor but fail. The legislation only allows the IRS to recharacterize the relationship as an employment relationship on a prospective basis.
Finally, the legislation amends Tax Court jurisdiction: Under the current IRC § 7436 mechanism for challenging worker classification, only the person for whom the services are performed may petition the Tax Court regarding misclassification of workers. The bill would expand current law to allow the worker/service provider to bring such a case as well.
At first blush, this legislation looks like it does good things for workers by clarifying their tax treatment, providing peace of mind, lowering previously unclear information reporting thresholds, and solving some of their estimated tax/mis-withholding issues. We have discussed these issues and challenges in our work on the sharing economy, as have Kathleen Thomas and Caroline Bruckner. From a purely tax point of view, we would readily admit that the proposals can make life simpler and less confusing for workers and help somewhat with tax compliance and enforcement. (Note that workers would still bear the burden of keeping track of and documenting their business expenses.) There are also certainly advantages to being classified as independent contractors for tax purposes, such as the ability to deduct unreimbursed expenses above the line.
The problem is that it’s not just about tax.
The Worker Classification Fights
There is an important battle going on right now in labor and employment law over the appropriate classification of workers in the gig/platform/sharing economy. Of course, worker classification fights are not new and predate the new economy. But the new platform models make these fights particularly salient for the new sector. The battle over worker classification is playing out not just in the U.S. but in other countries as well. And the outcomes in these fights don’t necessarily all point in the same direction. (For example, a U.K. employment tribunal just ruled that Uber drivers are not self employed under U.K. employment laws.)
In the platform economy context, the worker classification fight in the U.S. is taking place in federal class action litigations as well as before state administrative tribunals. At stake in the fight are the rights of workers to collectively bargain, and to overtime pay, minimum wage, child labor laws, and family and medical leave. The battle also holds implications for application of health and safety regulations and anti-discrimination laws. Employee classification confers many of these protections. Independent contractor classification does not. The work arrangements in the new sector are often gray and ambiguous enough that there are litigation risks to both sides. In many cases, either characterization may conceivably be plausible. As we have argued, the fact that gig workers are currently classified as independent contractors for tax and other purposes is due in large part to the fact that the platforms have opportunistically exercised their first-mover advantage to take the independent contractor position from the get-go.
Now, it is by no means the case that every gig worker desires employee classification. Some argue that employee classification comes with risks (for example, jobs may disappear if hiring costs rise). However, based on the amount of time, money, and energy that major sharing economy firms are spending to make sure independent contractor classification sticks, we can infer it’s the preferred classification for these firms.
Tax (and Withholding/Information Reporting) as a Pawn in the Worker Classification (and Budget) Fights
Our worry is that tax clarification of independent contractor status is a strategic step designed to win this broader (non-tax) regulatory war over worker classification. The risk is that “clarifying” the independent contractor status of workers for tax purposes through the introduction of an easy-to-meet safe harbor risks influencing and tilting the worker classification battle that is occurring in labor and employment law. While determinations of independent contractor status in other areas are theoretically independent from the tax determination, clarification on the tax side may help create presumptions elsewhere that independent contractor classification is normatively correct. While the precise legal tests governing worker classification differ across areas — we have, for example, the common law agency test, the ABC test, the economic realities test, and the IRS 20-factor test — the tests have elements in common: They all examine to some degree the nature of the relationship between the business and the worker, and they all pay attention to the control exercised by the business over the worker. If one field decides the classification question a certain way, there is likely to be some reverberation for the analysis in other fields.
Our specific concern is that “forced clarity” in tax can tilt the direction of the worker classification debate in a way desired by the platform businesses, industry lobbyists and the legislation’s supporters. As Eric Boehm at reason.com writes,
“The platforms themselves want this clarification included in the law as a way to short-circuit lawsuits, like one already launched by Uber drivers in California, aimed at forcing them to treat workers as employees.”
Boehm also writes that
“In return for clarifying that gig economy workers are contractors, Congress appears to be saying, those platforms will have to collect income taxes from those same workers. By doing that, Congress guarentees [sic] that more taxes will be paid—rather than the current system, which relies on individual contractors to correctly calculate and pay their own taxes, something that likely shortchanges the IRS to the tune of several billion per year, according to Caroline Bruckner, managing director of American University's Kogod Tax Policy Center.”
So if Boehm is right, tax withholding and “clarified” information reporting have now apparently become tools to avoid violating the Byrd rule. Again, it’s not that we don’t think withholding and information reporting are important for tax administration and compliance. But there’s clearly a lot more going on here than just tax.
The Dangers of “Ease” and “Simplification”
As the worker classification fight has developed, one of the tactical moves we have seen employed by both sides is to back reforms that grant piecemeal incremental protections for workers. For example, the City of Seattle passed an ordinance granting rideshare drivers the right to collectively bargain. Others have proposed creation of a third category of worker in between employee and independent contractor.
The nice thing about piecemeal approaches is that they give workers some protection in an environment in which worker-plaintiffs are not making much headway in class actions (due to the stalling effect of arbitration clauses). But the not-so-nice thing about piecemeal protections is they can be employed to undercut arguments in favor of full employee protections. Granting piecemeal protections risks creating a default in which people may be misled into thinking that there’s already a “special” rule that protects workers in this sector. Piecemeal protections can fuel arguments that many of the compliance and other issues for workers have been solved through piecemeal approaches, and therefore independent contractor treatment is not that bad.
Some elements of this legislation smack of piecemeal reforms. Sure, the legislation does clarify worker classification and makes things somewhat easier for workers by imposing withholding and lowering independent contractor information reporting thresholds. But we worry that these piecemeal improvements to the tax compliance plight of workers are just strategically thrown bones, designed to win the broader regulatory war. If we make life a little easier for these workers, this undercuts the need to question or challenge independent contractor classification.
The Problem with Written Contracting
Our other worry is that the legislation’s written contract requirement can lead to its proffered clarification being forced on workers ex ante. In essence, the legislation’s safe harbor objective tests are met if payors/service recipients (a.k.a. employers) can “persuade” workers to enter into a written contract upfront agreeing that independent contractor classification is appropriate. (As noted above, the other requirements to fall within the safe harbor are relatively easy to meet.)
Effects Beyond the Gig Economy
It’s important to note that even though the NEW GIG legislation was promoted as clarification for gig economy workers, nothing in the text of the proposed NEW GIG legislation or the JCT-prepared description limits this legislation to gig workers. Any worker who meets the three objective prongs for the safe harbor will be treated as an independent contractor and subject to independent contractor withholding. The legislation, then, provides tremendous leeway for service recipients/payors outside the gig economy to structure work relationships ex ante to ensure that safe harbor independent contractor classification is met (and employee protections diluted).
It’s Not Just About Tax
To be clear, we make no claim that employee classification is definitely the correct or more desirable one across all fields. Some might argue that the extensive protections that come with employee classification impose too high a cost. Others may argue that even if a worker wins employee classification, the economic impacts of such classification may not be positive for the worker in the long run (for example, when the firm shuts down and the job goes away). Still others may argue that the tax advantages of independent contractor classification outweigh the non-tax disadvantages. And still others may genuinely believe upon careful analysis that a worker is more properly classified as an employee rather than an independent contractor.
Our point, rather, is that one cannot read this new tax legislation in a vacuum. If one is going to sign off on this type of legislation, one should at least be aware of what the far-reaching consequences may be in order to make a conscious determination that it’s still worth doing despite these wide-ranging non-tax risks and costs. Or, if one’s underlying normative goal is to harness tax reform in order to dilute worker protections in pursuit of business growth, one should be transparent about that too.
Tax experts naturally focus on tax policy and tax administration issues. And tax clarification and incremental simplification for workers sound like great ideas if the fight arena is just about tax. But it isn’t. Having done academic work in this area for a while alongside labor and employment law scholars, we have come to realize that there are many, many players (industry, for example) with a large non-tax stake in this fight. And it’s not surprising that these proposals are finding support among business interests, advocates and lobbyists for sharing economy firms, and business-interested congresspersons.
In short, well-intentioned technical tax experts need to appreciate how this “clarification” of independent contractor classification in the tax area will likely reverberate into other areas of law and risk compromising workers’ ability to secure other important protections. Fundamentally, this high-stakes worker classification fight is not just about tax.