Wednesday, October 6, 2021
Richard Winchester (Seton Hall; Google Scholar), A GILTI Fix for an Employment Tax Glitch, 48 Pepp. L. Rev. 915 (2021):
When a self-employed individual operates through a business entity, they can frequently dictate the extent to which the firm's profits are included in their employment tax base. That permits such individuals to control how much employment tax they pay, if any. They enjoy this power because the rules permit them to dictate whether the earnings they derive through the firm count as labor income, which is subject to employment tax, or the returns on any capital they have invested in the business. The GILTI rules enacted as part of the 2017 Tax Act contain an assumption that amounts invested in capital generally earn a 10 percent annual rate of return. That same assumption can be used to determine whether the earnings of a self-employed individual count as labor income or returns to capital. Such a mandatory rule would eliminate the abusive practices that self-employed individuals currently utilize, permitting the entire employment tax system operate in a more equitable way.
The mere existence of tax reduction opportunities jeopardizes the integrity of the employment tax base. Equally important, the tax system cannot function in a fair and equitable way when individuals can control their tax liability. Simply put, individuals who are in materially similar situations will pay vastly different amounts in tax. That alone offends basic notions of equity. However, it is also difficult for the interests of fairness and equity to be served when the system permits an individual to dictate the rules they will observe and how they will observe them. When such options are available, tax outcomes will partly reflect how successfully someone has employed strategic measures to artificially reduce their tax liability.
The employment tax system is way overdue for reform. The 2017 Tax Act did nothing to improve the situation, and it may have increased the incentives for taxpayers to exploit the system’s shortcomings. However, the GILTI rules may offer policymakers a framework for real and lasting reform.