In the year-end scramble to pass the GOP Tax Cuts and Jobs Act, one of the more contentious negotiating points involved provisions for pass-through entities such as sole proprietorships, partnerships, and S-Corps. When the dust settled, the final version created powerful incentives for workers to capitalize on tax savings and jump headfirst into the gig economy.
But is that bet a sure thing for those workers…and the companies looking to engage them? Like the tax plan itself, it’s complicated.
The Basic Facts
The permanent reduction of the corporate tax rate to 21 percent got big attention, but there was no equivalent windfall for pass-through entities taxed at a higher personal rate. (By the way, 95% of businesses in the U.S. are categorized as pass-throughs, according to the Brookings Institute.)
So, a provision was added to allow those entities to deduct 20 percent of their revenue from their taxable income upfront. Designed in theory to reduce the disparity between corporate and individual rates—and to protect Government revenues—in practice it will fuel the trend towards independent contracting that’s already well underway.
Four Effects of the Pass-Through Provision
If your firm works with independent contractors, here are some implications you should take into consideration:
1. The “in-between” talent pool will grow.
Large enterprises typically turn to two primary options for flexible labor and outside expertise:
- temporary employees onboarded through a managed services program (MSP) or staffing firm
- big consulting firms, which offer global reach and top talent but at a premium due to overhead.
With the tax change, a third path will increasingly come into play, one that will require firms to pay closer attention to spend that’s outside the scope of these traditional programs.
2. Scrutiny on SOW projects will rise.
SOW contracts have long provided a mechanism for enterprising business leaders to skirt centralized program requirements. The rise of more corp-to-corp relationships may generate additional leverage for HR and procurement to inject more rigor into SOW evaluations. But, it might also squeeze out previously under-the-radar talent who fail to meet exacting contracting requirements.
3. Independence comes at a cost (literally).
The paperwork and legwork required for incorporation may dull some of the shine of the tax benefits. The relative simplicity of a sole proprietorship contrasts with requirements such as expense compliance, payroll management, and business insurance. That’s why the tax plan is a boon for lawyers and third parties marketing turnkey self-employment services.
4. Companies walk a fine line between employees and independents.
Even if independents self-select, companies aren’t off the hook for misclassification penalties. According to a recent New York Times article, “Many employers are already pushing the boundaries… 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.”
Also keep in mind that local and state taxing entities will become more hypervigilant as their tax revenue drops. And from a policy perspective, the employer protections afforded W2 employees—such as workers compensation and anti-discrimination laws—may face diminishing value.
Prepare for Workforce Changes Now
By incentivizing incorporation, the new tax plan stands to shift the dynamics of how employers engage with independent contractors. The rapid ascension of the gig economy demands a careful approach to workforce planning that balances freedom with flexibility, without losing sight of compliance.
To further explore the effects of the tax plan changes on your contingent workforce strategy, register for TalentWave’s upcoming HCI webinar, Decoding the Tax Law’s Impact on Independent Contractor Engagement.