The Treasury Inspector General for Tax Administration (TIGTA) recently released a report making some significant recommendations to the IRS to improve taxpayer compliance in the gig economy.
While the scope of the audit was intended to focus on compliance with self-employment taxes, the TIGTA quickly realized that the threshold and transaction limits for form 1099-K reporting between payers who classify as Third Party Settlement Organizations (TPSOs) versus payers who classify as Payment Settlement Entities (PSEs) was a significant contributor to the overall tax gap.
To estimate the potential value of this gap, TIGTA studied reporting details associated with three payers who did not apply limits for 2016, and analyzed the impact of potential underreporting if the threshold and transaction limits had been applied. TIGTA concluded that 95 percent of the taxpayers associated with just those three payers would not have been reported.
TIGTA went on to conclude that IRS tax gap studies indicate that 63 percent of income is misreported when third parties do not provide a form 1099 to the IRS—so when applying that figure to the underreported amounts from just those three payers in 2016, TIGTA estimated it could have been $3.7 billion of misreported income.
More than gaps in self-employment tax
Again, the emphasis of the TIGTA audit was to measure compliance with self-employment tax reporting. However, the form 1099-K threshold and transaction limit gaps discussed in the report aligns with some of the points that I highlighted in an article that I wrote recently about states taking action to close this gap.
In that article, I included examples of underreported income attributed to gig economy workers who do not receive form 1099-K as a result of IRS reporting threshold and transaction limits for that form. I also discussed the dichotomy between the form 1099-MISC and form 1099-K since these forms are both used for reporting the same types of payments and to the same recipients—yet follow entirely different sets of reporting rules. For clarity, the form 1099-MISC is required to be reported for payments made to independent workers when the aggregate amounts paid in a calendar year reach at least $600.
Conversely, the form 1099-K is required to be reported by Third Party Settlement Organizations (TPSO’s) when aggregate amounts paid in a calendar year reach at least $20,000 and are paid over at least 200 transactions. The only difference is how they are paid – if the payor chooses to wire funds to the recipient, than form 1099-MISC is required. If the payor chooses to utilize an electronic payment platform to reimburse the recipient, than the form 1099-K rules apply.
When a form 1099-K is not issued, the IRS does not have a way of identifying non-compliance unless it receives a referral from other sources such as the States. Since only a handful of states have actually adopted legislation that requires reporting at lower thresholds and eliminates transaction limits for TPSOs, the IRS is likely receiving only a fraction of referrals where income may have been misreported. Even then, the TIGTA report indicated that the IRS can only get to about 15 percent of what is routed to it for research, so making significant strides to close this tax gap is not possible with the current methods and processes that are in place.
TIGTA finds significant misreporting of income
Compared to the article that I wrote previously on this topic, the TIGTA report took a different approach when analyzing the effect that the disparate reporting rules have on taxpayers and the overall tax gap impacting the U.S. economy.
Specifically, TIGTA analyzed 2016 data associated with only three gig economy payers who did not apply the $20,000 threshold and 200 transaction limit – so all payments were reported.
TIGTA found that if those payers had classified themselves as TPSOs and applied the threshold and transaction limit, the IRS would only have received reporting on 54 percent of the income that those payers paid and that 95 percent of the taxpayers that received payments from those payers would not have received a form 1099 to aid them in filing their annual income tax returns. Taking that in the inverse it seems very clear that the majority of individuals under TPSOs may not be meeting the threshold to receive a 1099-K and a large percentage of the income is not being reported.
A picture of rising non-compliance
The TIGTA conclusions certainly paint a picture of rising non-compliance directly attributed to information reporting gaps created by the emergence of the gig economy and coupled with outdated tax information reporting requirements. A couple of weeks ago, I predicted that we would see more states adopt legislation to eliminate the transaction requirement and minimize the threshold for form 1099-K reporting—but it appears that the IRS may beat them to it. One of the eleven findings in the report was a recommendation to the IRS to “work with the Treasury Office of Tax Policy to pursue regulatory or legislative change relating to the third-party reporting thresholds established in IRC 6050W” … and the IRS agreed.
With constantly changing thresholds, transaction limits, and other nuances continuing to unfold, I encourage US payers to consider investment in modern tax information reporting solutions that can produce electronic files necessary for both IRS and State information reporting purposes.
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