Taxing Workers in the Gig Economy
Participation in the gig economy has grown steadily in recent years, facilitated in part by popular online and app services such as Uber, Lyft, AirBnB, VRBO, and TaskRabbit, as well as selling platforms available through Amazon, eBay, and Etsy. A recent survey by Upwork suggests that more than 56 million people are involved in freelance or “side-hustle” work of one kind or another. Many people who are new to this type of work may not be aware of the resulting tax implications, a situation made worse by the fact that existing tax law effectively creates a 1099 reporting loophole, making it difficult for the IRS to determine if a taxpayer has correctly reported their self-employment income and causing confusion among taxpayers about their filing requirements. A number of steps are being proposed by government agencies and think-tanks to help improve taxpayer compliance. To this end, the IRS recently published an informal notice that describes various tax considerations for workers in the gig economy. Here are the key takeaways from that notice.
1. The activity is taxable.
The first thing to be aware of is that earnings from work in the gig economy are taxable. This is true even if the activity is conducted on a part-time basis or as a side business. Likewise, it’s true even if payments are made in cash and regardless of whether the worker receives a 1099-MISC, 1099-K, W-2, or other information return. As an aside, the threshold for filing a 1099-MISC is only $600, but the threshold for filing a 1099-K is 200 transactions and gross payments in excess of $20,000. Many workers fall below these annual levels, but that doesn’t mean the income they earn through online sales, ride sharing, or vacation home rental isn’t taxable.
2. Some expenses are deductible.
Taxpayers who participate in the gig economy may be able to deduct certain expenses. For example, a taxpayer who uses his or her car for business may qualify to claim the standard mileage rate, which is 58 cents per mile for 2019. Similarly, a taxpayer who purchases supplies that are used to make products sold in an online store may deduct the cost of those supplies. Good record-keeping is essential for any deductions claimed on a tax return. If the IRS questions a deduction, the taxpayer bears the burden of substantiation. In addition, it is important to keep in mind that deducting personal, living, or family expenses is not permitted. For example, even though a deduction is available for business use of a vehicle, no deduction is available personal use, including commuting expenses.
3. There are special rules for rental property.
Some taxpayers have a second home that they rent out year-round with no personal use. Other taxpayers may rent out their primary residence or a vacation home for part of the year, while utilizing it for personal use during the remainder. Special rules apply to scenarios where there is personal use of the property. Likewise, whether a taxpayer materially participates in the rental activity or is considered to be a real estate professional will determine if the rental activity is treated as a passive activity. If the activity is passive, then losses are deductible only to the extent that there is offsetting passive income. A detailed discussion of these rules is beyond the scope of this article, but taxpayers should be aware that, among other factors, duration of the rental, personal use of the property, and the amount of time the taxpayer expends on the rental activity all have important effects on whether income is reportable and expenses are deductible.
4. Participants may need to make estimated tax payments.
Just as there has been a steady increase in the number of workers participating in the gig economy, there has been an increase in the number of taxpayers who have had to pay an estimated tax penalty for insufficient withholdings or failure to make estimated payments. For most gig economy workers, tax withholding is not an option, so estimated payments must be made. Many workers are not aware of this requirement, while others may miss a payment or make only partial payments. Estimated tax payments are due on April 15, June 15, September 15, and January 15 of each year. IRS Form 1040-ES can be used to calculate the amount of the required estimated payments.
5. There are different ways to pay your tax.
Estimated payments and a balance due showing on a tax return can both be mailed in to the IRS or can be made electronically. The fastest and easiest way to make estimated tax payments is through IRS Direct Pay, available at www.irs.gov. Alternatively, taxpayers can use the Electronic Federal Tax Payment System, available at www.eftps.gov. It is important to remember that failing to pay the correct amount of self-employment tax, either because of underreporting income or claiming deductions to which one is not entitled, will decrease the amount of Social Security benefits to which the taxpayer is entitled upon reaching retirement age.
6. Taxpayers should check their withholding.
Taxpayers involved in the gig economy who are employees elsewhere can often avoid making estimated tax payments by instructing their employer to increase the amount of tax withheld from their paychecks. To estimate the correct amount of tax withholding, taxpayers can use the withholding calculator at www.irs.gov. After determining the amount of their withholding, the taxpayer will need to file IRS Form W-4 with the employer to request the additional withholding. This option may or may not be available for state and local taxes, so these may still necessitate making quarterly estimated payments.
There are many other important rules, both tax and non-tax, that affect workers participating in the gig economy. For example, depending on the type of activity, it may be necessary to pay state and local sales, occupancy, or excise taxes, perhaps to more than one state or locality. This is a particular concern in light of the recent and widespread changes in state laws that now require sales tax to be collected where a remote seller has an economic nexus with another state. In addition, whether a gig economy worker is an independent contractor or an employee implicates various state and federal labor laws, such as minimum wage and overtime, workers compensation, and unemployment compensation. The list of potential issues is long, but perhaps the key point to keep in mind is that the rapid growth of the gig economy has caused both the IRS and state taxing authorities to take notice. The dollars at stake are substantial: tax underpayments from self-employment income are estimated to be billions of dollars each year, but the penalties for failure to comply with filing obligations are also steep. As a result, if you are already involved in the gig economy or about to start your own side hustle, be sure to familiarize yourself with your tax filing requirements to avoid running afoul of the rules.
DISCLAIMER: The foregoing does not constitute legal advice and has been prepared for informational purposes only. Please contact us directly with questions about how these and other laws and procedures relate to your specific situation.
Prepared by GKH attorney Doug Smith. Attorney Smith practices in the areas of Estate Planning and Administration, Business Succession Planning, Nonprofit Organization, Corporate and Commercial Law, and Tax Law.