ALBUQUERQUE, N.M. — The new tax law has created excitement in the tax-planning community. The drafters of this legislation probably intended some restructurings to benefit from the law. Other responses will not have been intended or desired.
Employees must pay Social Security taxes on their wages. Their employers also pay the same amount of tax on behalf of the employee. This tax is 6.2 percent up to an inflation-adjusted wage base and 1.45 percent on all wages.
The 6.2 percent is for OASDI, which means old age survivor and disability insurance. The 1.45 percent is for Medicare. The total burden is then 7.65 percent for the employee and 7.65 percent for the employer, so the total tax burden is 15.3 percent of wages.
Self-employed persons pay both halves of this tax. Because employers can deduct their share of the tax, self-employed people pay the 15.3 percent on only 92.35 percent of their net earnings (100 percent minus the 7.65 percent that an employer would deduct).
Some employers have tried to classify workers as self-employed to save the employer share of the Social Security taxes. Worker classification can also affect whom the employer must cover in benefit programs.
Whether someone is an employee or is self-employed is often clear as mud. The IRS has developed worker classification guidelines that require an assessment of a variety of factors. Any time the law resorts to a factor analysis, there are many cases for which reasonable people can, while being reasonable, reach different conclusions.
The new law allows a self-employed person a deduction for 20 percent of their business income. This deduction is not available for employees paid on a W-2 form. Workers who previously preferred employee status may now welcome self-employed status.
The new law also eliminates an employee’s ability to deduct any non-reimbursed employee business expenses. Self-employed persons may still deduct these items. Again, perhaps a reason to prefer self-employed status?
Of course, the worker must also consider the need to pay both halves of the Social Security tax. In most cases the self-employed person will also need to get a New Mexico CRS number to file and pay gross receipts tax.
Robert Frost, in “The Road Not Taken,” tells us that way leads on to way. Once we pick one path, it changes everything, and we can never really go back some other day to try a different path. That different path has itself changed while we pursued the other one.
The new law will forever change preferences for employee or self-employed status. The employer itself has new reasons to prefer one or the other. In pre-2018 days, the preference may have been based on shifting payroll tax burdens and excluding workers from benefit plans.
Most employers are “flow-through” entities such as partnerships (which include multi-owner LLCs) and S corporations. Owners of flow-through entities now also get a 20 percent deduction for their business income.
Owners are often more likely to be “high income” than their workers. The new law limits the 20 percent deduction for high-income taxpayers. For a non-service business, the impact of the limitation may be cushioned by high W-2 wages paid to workers.
The employer may now prefer to have employees paid on a Form W-2 if that classification helps a high-income owner to maximize the 20 percent business deduction.
The answer is then quite clear – it depends. For those who think that too much of a business’ resources are “wasted” on tax planning, this new, some say simplified, law will not be your cup of tea.
Some readers might say, “What do you mean quite clear – it depends.” That’s anything but clear! Well, I disagree. As Humpty Dumpty, my favorite wordsmith, said, “When I use a word it means exactly what I intend it to mean, neither more nor less.”
It depends is a clear answer to a tax planner. We live with uncertainty. If you find a tax planner who is certain of his or her conclusions, find a different tax planner. The first one is delusional and dangerous.
This new law simply ramps up the uncertainty of the tax planner and makes him or her more valuable to the business. The “waste” from the planner’s fees will fall not on the business, which will benefit, but on government revenues.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.