Fixing The Tax Reporting Gap In The Gig Economy

The coronavirus pandemic has magnified the problem of nonreporting and underreporting of gig work income by taxpayers who haven’t been getting information reporting from the online platforms they use to coordinate their work. Few workers seem to understand their obligations because of information reporting requirements that are long outdated, but the recent upheaval in parts of the gig economy combined with the sharp increase in unemployment overall makes this a particularly critical time for a solution.

The lack of information reporting is “a big problem that people have ignored for too long, and now we’re dealing with the consequences of that,” said Caroline Bruckner of American University Kogod School of Business. It’s proven especially devastating for workers who are now trying to substantiate their earnings to apply for unemployment insurance, she said. “In the middle of a pandemic, Congress was scrambling to give UI to people whose livelihoods had been decimated, but in some cases, platform workers couldn’t get their earnings substantiated because platforms don’t give them any kind of Form 1099. It’s a double whammy for online gig workers,” she said.

Increased information reporting is needed because many suddenly unemployed workers will likely migrate to online platforms out of economic necessity. Ten years ago, the debate about how to deal with self-employed workers focused on the administrative burdens on small businesses, Bruckner said. “But there are now billion-dollar platform companies that need to help millions of workers comply with their tax filing obligations, because they take a cut [for coordinating work] and they are a centralized point for tax administration purposes,” she said.

Gig work can be an entry point into the labor force and is an increasingly important one for younger workers. The growing number of millennials choosing that path is an important consideration for tax policy because independent workers have a greater responsibility to maintain good business records for tax purposes, and although learning those skills isn’t difficult, it requires individuals to create a recordkeeping system. That requirement places an extra burden on those workers, most of whom view their gig work as a supplemental source of income, Bruckner said. “The majority of taxpayers are still W-2 workers, but there is a large and growing population that does independent work, particularly online and as a supplement to their primary income,” she said.

“What we see across the board when talking to workers is a lot of misconceptions about what can be deducted, and how to track and deduct expenses so that all of that is in order in case of an audit,” said Garrett Watson of the Tax Foundation. He said it’s important for gig economy workers to learn how to properly account for expenses not only for tax purposes, but also to ensure they have a complete understanding of their actual income.

‘Congress was scrambling to give UI to people whose livelihoods had been decimated, but in some cases, platform workers couldn’t get their earnings substantiated because platforms don’t give them any kind of Form 1099,’ Bruckner said.

Before the coronavirus pandemic, the growing population of gig workers who were supplementing other income sources often either was unaware of or failed to report their additional earnings. Once the pandemic hit and Congress recognized that it needed to send unemployment insurance payments to self-employed workers as well, labor experts were surprised that the Congressional Budget Office’s estimate of 5 million workers who would claim them was too low by slightly more than 50 percent, since 10.7 million have filed to date, Bruckner noted.

Part of the problem is that online platforms mostly hadn’t been required to give their service providers a Form 1099 because under section 6050W, no information reporting is required from third-party settlement organizations unless the payee has more than 200 transactions that collectively exceed $20,000. “Everyone knows that safe harbor filing threshold is not where it should be,” Bruckner said.

A looming problem for gig workers in the short run is the July 15 deadline for tax return filing and payments and the same deadline for estimated quarterly payments, Watson said. He noted that that could create a wall of tax payment deadlines for gig workers to run into all at once. “If the intent is to help those who don’t have liquidity, there may be ways to provide relief on the payment side, such as waiving penalties for late payments,” he said.

Legislative Solutions

On June 4 Senate Majority Whip and taxwriter John Thune, R-S.D., reintroduced the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2019 (S. 700), which would add a safe harbor permitting a gig worker to be classified as an independent contractor for tax purposes. (Prior coverage: Tax Notes Federal, June 8, 2020, p. 1801.) The safe harbor applies if the service provider incurs deductible expenses under section 162 and if a significant portion of those expenses aren’t reimbursed. The service provider must agree to perform a service for a particular amount of time, to achieve a specific result, or to complete a specific task.

One of four other factors must also be met: the service provider (1) must have a significant investment in assets or training applicable to the service performed, (2) must not be required to perform services exclusively for the service recipient or payer, (3) must not have been treated as an employee by the service recipient or payer for substantially the same services in the prior year, or (4) must not be compensated on a primarily hourly basis.

Several legislative approaches could address the absence of information reporting and provide an immediate remedy to the problem of underreporting of gig income, but some legislators want to tie information reporting to worker misclassification issues, which is a shortsighted approach in the middle of a pandemic, Bruckner said. Congress could bifurcate the information reporting and misclassification issues and move ahead quickly on lowering the information reporting thresholds, she said. Some states, including Massachusetts, Vermont, Virginia, and Maryland, are already doing that.

A looming problem for gig workers in the short run is the July 15 deadline for tax return filing and payments and the same deadline for estimated quarterly payments, Watson said.

“The bipartisan legislation is there,” Bruckner said, pointing to a proposal in the Small Business Owners’ Tax Simplification Act (H.R. 3717), introduced by House Small Business Committee Chair Nydia M. Velázquez, D-N.Y., and ranking member Steve Chabot, R-Ohio, to increase the threshold for filing a Form 1099-MISC from $600 to $1,500 and adjust it for inflation. The bill would also decrease the dollar threshold in section 6050W for filing a Form 1099-K to $1,500 and eliminate the transaction threshold.

The Velázquez-Chabot bill largely avoids the worker classification questions, but includes an amendment to section 3402(p) that prevents voluntary withholding agreements from being taken into account in determining whether a party to such an agreement is an employee or employer. “Information reporting for millions of taxpayers is being held up by the legislative agendas of platform companies that just laid off thousands of employees,” Bruckner noted.

Increasing voluntary withholding by online platforms might make workers a bit more dependent on them, so that it’s slightly harder to spin off into creating a new business. “If [new business formation] is a priority, any effort that makes workers feel more comfortable with calculating their expenses and identifying their net income and liability makes that more likely,” Watson said. He noted that there can be benefits to taxpayers gaining the skills necessary to comply with their tax obligations, because those skills transfer into small business ownership.

Standard Business Deduction

One option for reducing the complexity faced by gig workers is to simplify the process of claiming expenses. In a 2019 paper, Kathleen DeLaney Thomas proposed a standard business deduction (SBD) for small business owners, who could take the SBD instead of itemizing business expenses, eliminating Schedule C, “Profit or Loss From Business.” The SBD would be based on a fixed percentage of gross receipts, capped based on gross business receipts and total adjusted gross income, and available only for taxpayers who earn income subject to reporting on Form 1099. Businesses with little or no expenses would be ineligible.

The tax code already provides similar simplifying mechanisms for home offices and vehicle expenses, Watson noted. “There are some trade-offs,” he acknowledged, pointing out that gig workers may want to track their expenses to ensure that they have a complete picture of their net income and whether it’s better to itemize or not. The amount of the SBD would likely be set as a percentage of gross revenue and could differ based on type of gig work.

Whether an SBD is needed might in part be affected by how much effort is put into educating gig workers about their taxes.

Thomas wrote that “ideally, an SBD would roughly approximate business expenses for most taxpayers, although a slight windfall may be acceptable, as it would act as a subsidy for small businesses.” She proposed a 60 percent deduction for gig economy workers but said that additional study might help identify a more appropriate percentage.

Separate SBDs for different industries would be more accurate but could lead to gamesmanship, Thomas wrote. She suggested instead that Congress might consider two SBDs — a lower one for services that don’t have high overhead costs, such as child care, and a higher one for services that do, such as ride-sharing drivers — to minimize the likelihood of gamesmanship but also provide the simplification of the standard deduction. Thomas cautioned that for an SBD to work, the information reporting thresholds must be adjusted downward so that any workers using specific online intermediaries must get a Form 1099 if they earn more than $600.

Whether an SBD is needed might in part be affected by how much effort is put into educating gig workers about their taxes. If more workers were receiving Form 1099 because of a legislative change in the reporting thresholds, there might be increased awareness of tax responsibilities and less of a need for a standard deduction.

A Fast Fix

The growing need to change the information reporting thresholds has been exacerbated by the pandemic. But Congress could look at shoring up the long-standing deficiencies in information reporting as one opportunity to assist a growing number of small businesses in the gig economy.