Practically speaking, the new § 199A goes live this coming filing season, when taxpayers witness the effect of the supersized pass-through business deduction. Tax experts predict all manner of distortion and gaming. In particular, many worry that the provision creates strong incentives for workers to shift from employee to independent contractor status. For some, this means abandoning crucial worker protections and increasing employment instability; for others, it may simply be tax gaming.
In response to this concern, Shu-Yi Oei and Diane Ring offer a measured analysis of § 199A’s likely impact on worker classification. The authors avoid brash forecasting and instead consider various factors that affect the likelihood of such a shift, including incentives and guardrails built into § 199A, protections existing under the labor law, and current employment trends. In addition to quelling the direst doomsday predictions, the article provides a useful normative framework for those assessing outcomes under the new law.
Oei and Ring begin, helpfully, by summarizing § 199A. (By the way, their summary provides a clear, condensed account for any readers seeking a CliffsNotes approach to the new law.) Perhaps even more helpful for a tax law audience, they also explain the stakes of worker classification, describing the various labor protections available to employees and denied to independent contractors. These include collective bargaining rights, minimum wage and overtime protection, unpaid leave, health and safety regulations, antidiscrimination laws, and robust retirement, disability, and medical benefits. Shifting from employee to independent contractor work means losing these protections.
Having laid this foundation, Oei and Ring next discuss various factors that may mitigate extensive transformation of employees to independent contractors. For one, they explain, § 199A has built-in statutory guardrails that deny the deduction to many high-income taxpayers. These limitations apply to services in certain fields (such health, law, and accounting), as well as businesses that fail to meet minimum thresholds for employees or qualified depreciable assets. Such taxpayers face no incentive to reclassify because they are excluded from § 199A. Interestingly, the authors note that the employee threshold requirement for high-income taxpayers creates a countervailing incentive to hire more employees, which may somewhat offset the pressure to shift jobs to independent contractor status. Additionally, the law’s complexity as well as its scheduled phase-out may deter some taxpayers from reclassifying.
Misclassification enforcement is also an important part of the story. As Oei and Ring explain, a worker cannot simply elect her status. In theory, the structure of a job determines its classification, depending on the locus of control and the opportunity for upside gain or downside risk, as well as many other factors. Importantly, the § 199A proposed regulations create a rebuttable presumption that former employees who shift to independent contractor status should remain classified as employees. Thus, those who shift their work status in response to § 199A risk being reclassified by the IRS. Of course, as the authors point out, the likelihood of reclassification depends on IRS enforcement resources and priorities.
To the extent that § 199A does induce a shift to independent contractor status, some worry that this shift will hasten the trend towards greater workforce instability in the U.S., due to the loss of the protections listed above. In response to this concern, the authors look to employment trend data to conclude that the shift away from employee status in recent years may be less significant or at least more complex than often presented. In particular, much of the increase in independent contractor work has occurred among individuals who are primarily employed in W-2 work. As Oei and Ring point out, many of these individuals already benefit from employee protections and merely engage in independent contractor work for supplemental income. Interestingly, the fact that § 199A can subsidize workers’ efforts towards private income security may be a positive of the new law. Thus, Oei and Ring’s analysis leads them to conclude that § 199A’s effect on workers will vary depending on the industry and the nature of workforce participation, among other factors.
As a former legal aid attorney, I am especially interested in how this analysis might apply to low-wage misclassified workers, who I often represented in practice. Low-wage workers may be misclassified as independent contractors for a variety of reasons ranging from economic incentives to employers’ intentional evasion of labor protections. The workers are usually unaware that their classification excludes them from the labor protections that apply to employees. Unfortunately, workers rarely sought legal advice until they had been denied benefits due to their status. Of course, § 199A does not change this dynamic. It merely adds another incentive in favor of independent contractor classification. For low-wage workers who need money today, and do not have the luxury to worry about being denied benefits tomorrow, the extra deduction is yet another reason not to challenge their work classification until it is too late. Although worker classification can be rebutted in benefits hearings, doing so without an attorney is difficult. For each person we were able to help, there are surely countless others who simply lost access to benefits. These considerations add additional texture to Oei and Ring’s analysis.
Classification matters for many reasons. The introduction of § 199A raises the stakes even higher. Oei and Ring’s article provides vital legal background and analysis, which scholars, advocates, and policymakers would do well to heed as the new law goes into full effect.