The Relation between Payroll and Income Tax Avoidance

76 Pages Posted: 1 Oct 2021

See all articles by Michael Marin

Michael Marin

University of Toronto at Mississauga - Department of Management

Date Written: September 30, 2021

Abstract

Payroll taxes, such as contributions mandated through the Federal Insurance Contributions Act
(FICA), represent a considerable expense for businesses and are a large source of government
revenue. Considering that employers pay approximately 50% of FICA, payroll taxes have a
material impact on firm profitability. Despite the large cost, little is known about the determinants
of payroll tax avoidance. By misclassifying employees as independent contractors, a firm can
avoid their portion of FICA contributions and a variety of other employee related costs. This paper
utilizes publicly available compliance action data from the Wage and Hour Division (i.e., WHD)
of the United States Department of Labor (i.e., DOL) to identify employee misclassification and
to empirically identify whether firms that avoid income taxes also avoid payroll taxes. This paper
documents two main results. First, income tax avoidance, proxied by CashETR, is positively
related to the likelihood of a successful discovery of a Fair Labor Standards Act (i.e., FLSA)
violation during a Wage and Hour Division audit. Second, firms reduce their income tax avoidance
following the discovery of FLSA violations.

Keywords: Tax Planning, Employee Classification, Non-Income Taxes

JEL Classification: M4

Suggested Citation

Marin, Michael, The Relation between Payroll and Income Tax Avoidance (September 30, 2021). Available at SSRN: https://ssrn.com/abstract=3933173 or http://dx.doi.org/10.2139/ssrn.3933173

Michael Marin (Contact Author)

University of Toronto at Mississauga - Department of Management ( email )


Canada

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