The Other Labor Law: Understanding the Tax-Work Intersection
Shu-Yi Oei (Professor of Law, Boston College Law School)
Diane M. Ring (Professor of Law, Boston College Law School)
In Dynamex Operations West v. Superior Court of Los Angeles County, the California Supreme Court modified the test for determining whether a worker is classified as an employee or independent contractor for employment and labor law purposes. The ruling is expected to make it harder for hiring firms to classify workers as independent contractors, and some predict it may lead to fundamental shifts in the business model of firms such as Uber, which have broadly classified large numbers of drivers as independent contractors but now may be forced to reclassify them as employees. Thus, because of the increased legal protections employee status provides, the Dynamex ruling has been widely celebrated by employment and labor law advocates as a positive for workers.
On the tax side, however, the story looks a bit different. Taxpayers operating as independent contractor sole proprietors have long enjoyed more favorable tax deductions than employees under U.S. tax law. In addition, in December 2017, Congress enacted new Code Section 199A, which allows business sole proprietors and other noncorporate taxpayers a possible 20% deduction for “qualified business income.” The § 199A qualified business income deduction may be claimed by independent contractors but not employees, which means that a reclassification of a worker as an employee will cause the worker to not be eligible for the deduction. Thus, what appears to be a positive in terms of labor and employment law direct protections may be costly in terms of tax treatment and benefits. Critics have argued that the new § 199A deduction may cause workers to prefer independent contractor classification and to be more amenable to hiring firms’ attempts at so classifying them.
The different reactions to the recent Dynamex decision—celebration by labor and employment law advocates, caution from tax lawyers—is symptomatic of a deeper disjuncture that has underpinned contemporary discussion of the worker classification issue. Even prior to the enactment of new § 199A and Dynamex, tax and labor/employment lawyers have long tended to talk past each other in matters of worker classification and protection and its consequences. When labor law scholars talk about worker classification, the conversation usually focuses on direct protections under labor and employment law. The labor law conversation by and large ignores the effects of tax on worker choices and the economic position of workers. On the flip side, when tax scholars think about the effects of tax on labor, the conversation largely focuses on labor supply and labor demand and on whether taxes are efficient, equitable, or administrable. The tax conversation equally ignores the effect of taxes on shaping hiring firm and worker preference, choices, and protections. Thus, both tax and labor/employer law scholars miss the important interior effects of tax on the shape of workplace protections and arrangements. These tax effects predate and extend beyond § 199A. For example, U.S. tax law differs in its treatment of independently operating sole proprietors and employees by providing more favorable “above the line” deductions for the trade or business expenses of independent contractors than employees. In addition, tax law makes employers responsible for the employer half of employment taxes, but independent contractors are responsible for all employment taxes. Furthermore, tax law provides for withholding of employee wages but only for information reporting with respect to independent contractor wages.
In this paper, we cast new light on the worker classification story in the U.S. by examining how U.S. tax law navigated, contributed to, and may have potentially exacerbated the independent contractor-employee line over time. Our research suggests the gradual drawing of an increasingly sharp line in tax law between how employees and independently operating contractors are treated in a number of respects. The drawing of this line has stemmed in large part from concerns over simplification, administrability, and the creation of a modern tax base, not by concerns over workplace law or worker structures or protections. However, the obvious result of these moves has been to cleave sharper and sharper distinctions between those working as wage employees and others that in important ways favor classification as independent contractors. While this line may not have been projected to have had much effect on work arrangements in the old economy, the creation and firming up of the tax line has created conditions amenable to allowing firms the leeway to later push for independent classification of workers in a changing workforce when conditions are ripe.
In our paper, we focus on five main areas to illustrate this dynamic: (1) the evolution of stricter limitations on deductibility of employee expenses as opposed to independent contractor expenses; (2) the decision to allocate responsibility for employment (FICA and FUTA) tax between employers and employees (but not between independent contractors and those who hire them); (3) the gradual systemization of the employee fringe benefit field; (4) the move towards withholding for employee wages but information reporting for independent contractor earnings; (5) the 2017 enactment of IRC § 199A. These areas are not the exclusive avenues by which tax law exerts an influence on worker classification choices and dynamics. Moreover, we make no empirical claims regarding the actual extent of how each area influences workplace choices and dynamics. But what is clear is that each of these areas has potential to tilt or provide a thumb on the scale affecting the classification and treatment of workers and work.
By retelling the worker classification story in U.S. law and highlighting tax law’s unnoticed role in encouraging, discouraging, or facilitating worker classification preferences and practices, we aim to illuminate tax law’s role in alternatively subsidizing or subverting labor law’s moves and choices. Tax law sometimes magnifies the impacts of labor law’s policy choices. But tax law sometimes also creates incentives and effects that resist or subvert those moves and choices. There are upsides to having two major areas of law push in the same direction. But there may also be unappreciated positives to having two areas push in opposite directions. Our analysis provides a first step towards fully understanding the role tax has played—and the role it should play—in influencing worker classification choices over time.