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House GOP Cuts Taxes for Pass-Through Businesses: Could there be a Shift to Self Employment?

posted July 25, 2018

Howard Gleckman, Forbes Magazine Contributor, Jul 24, 2018

For the second time in a week, House Republicans are pushing policy changes that seem to conflict with key elements of last year’s Tax Cuts and Jobs Act (TCJA). This time, the House says it is worried about the growing numbers of self-employed workers and is giving the IRS 90 days to explain how it will improve their tax compliance.

In the committee report accompanying its version of the agency’s 2019 budget bill, the House Appropriations panel said it was “concerned a shift towards self-employed and independent contracting within an increasingly gig-based economy will correspondingly increase underpayment and underreporting of self-employed taxes.”  What the House, which approved the measure late last week, didn’t say: That shift is being accelerated by the special 20% tax deduction for the self-employed and other pass-through businesses that was a big part of the TCJA that House Republicans enthusiastically backed.

Medical Tax Deduction

This comes hard on the heels of a bill passed last week by the House Ways & Means Committee that expands the use of the medical expense deduction—a tax preference that the same House Republicans tried to repeal just seven months ago.

The House plans to kill the itemized deduction for medical expenses was rejected last December by the Senate. The final version of the TCJA not only preserved the deduction but made it available to more taxpayers through 2018. Now, the Ways & Means panel has voted to expand the set of qualifying medical expenses to include gym membership and sports equipment. The full House is expected to approve the measure later this week.

Congress passes tax bills because the measures collect enough votes. But expanding a deduction just months after voting to repeal it seems a little odd, even for Congress. And worrying about the underpayment of taxes by independent contractors just months after creating an enormous new incentive for people to both become independent contractors and to use that status to game the tax system seems beyond odd.

The Temptation for Abuse

The committee’s concern is legitimate. Self-employment, in the gig economy and elsewhere, creates opportunities for people to avoid taxes by, say, being paid in cash. And for years, small businesses of all kinds have underpaid taxes by failing to report income or inappropriately claiming deductions for expenses that are only barely related to the production of income. For instance, how many business owners lease the family car through their firm to claim a tax deduction?

Using that vehicle for a few hours a day as a Lyft driver or renting out a back bedroom on Airbnb makes those choices more complicated, and no doubt makes tax avoidance more tempting. But the TCJA makes the problem even worse.

Setting Up the Agency to Fail?

And it does so not only by creating generous new tax breaks for the sole proprietors the House seems so worried about but also by cutting taxes for other pass-throughs such as partnerships, about which the House does not seem very concerned.

It all makes me wonder how committed the House GOP is to the TCJA.

By giving the IRS 90 days to come up with a solution to the problem, the House is doing little more than setting the agency up to fail. If the service tries to impose—and enforce– tough new anti-abuse rules on self-employed taxpayers and other small businesses, many members of Congress surely will accuse the agency of being filled with a bunch of thugs. If the IRS does not act, it will be blamed for increasing the tax gap and adding tens of billions of dollars to the budget deficit.

Meanwhile, the House will continue to try to have it both ways: Taking credit for closing “loopholes” while satisfying special interests by widening them.

 

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