Caroline Bruckner is the managing director of the Kogod Tax Policy Center at the Kogod School of Business at American University in Washington, DC. She is heavily involved in consulting with Congress on tax policy and in 2016 published the study Shortchanged: The Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy.
Sovos recently spoke with Professor Bruckner about tax policy and tax reporting in the sharing economy, sometimes referred to as the gig economy. She addressed the controversy surrounding 1099-MISC vs. 1099-K tax reporting.
Currently, most companies use form 1099-MISC to report standard non-employee compensation. However, organizations deemed third-party settlement organizations (TPSOs) that process credit-card payments from third-party payers to service providers report non-employee income using form 1099-K.
Form 1099-K, then, is essentially a digital, new economy version of form 1099-MISC—with one major difference. While a service provider only needs to earn $600 in a given year to trigger a form 1099-MISC, the threshold for a TPSO to report earnings via 1099-K is both $20,000 and 200 transactions in a year. The overwhelming majority of sharing-economy workers don’t meet the 1099-K threshold, so TPSOs are not required to send those workers 1099-K forms.
Essentially, that policy leaves a massive gap of untaxed earnings among sharing-economy workers. Although independent service providers are responsible for filing tax returns and paying taxes on income earned via TPSOs, many do not file because they do not receive 1099-K forms and don’t know they have to file.
Not only does failure to file on a large scale contribute to the tax gap, which is the difference between taxes owed and taxes actually collected, it also means service providers don’t get credit for paying into programs such as Social Security and Medicare—programs providers themselves might need as they become too old or ill to work.
Bruckner revealed Congress had the chance to fix the 1099-K gap with the passage of the Tax Cuts and Jobs Act, but failed to do so. Here, she offers perspective on why the effort failed and what some of the ramifications of that failure might be.
Sovos: Filling the 1099-K gap seems like an obvious and politically acceptable way to bring in missing tax revenue. How did the 1099-K threshold come to exist?
Caroline Bruckner: It’s a fix that everyone acknowledges needs to happen. The 1099-MISC threshold hasn’t changed since 1954. In 2008, when Congress developed the much higher 1099-K threshold, the political environment at the time played a major role, but more importantly, policymakers just didn’t see what was going to happen with the extraordinary growth of platform companies.
The original idea behind the high threshold of the 1099-K rules was to protect auction sites like eBay. The vast majority of eBay sellers don’t make that much money for tax purposes. It’s like an online garage sale. There was an economic crisis in 2008 and a hotly contested presidential election. Congress didn’t want to penalize people selling things on eBay at that time, so it made sense to set the 1099-K threshold really high.
Ride-share and home-share services and platform companies were in their infancy at that time, and nobody thought of people being able to make the kind of money from those services that would drive significant tax revenue.
Sovos: What kind of impact does the high threshold have on tax revenues?
Caroline Bruckner: The average income of somebody like a ride-share driver ranges from about $3500-$6500 per year, which means that the form 1099-K $20,000 income reporting threshold isn’t being tripped by a significant portion of on-demand platform operators. This income would otherwise be reported on a Form 1099-MISC, but it isn’t because the payments are credit-card payments and the level of income doesn’t meet the 1099-K threshold.
The IRS says more than 40 percent of the tax gap – almost $200 billion – is attributable to misreporting of business income from individual filers who under report receipts or over-report expenses. When employers withhold income, there is about a 1 percent misreporting rate. When there is no withholding or tax information reporting – for instance, when a driver doesn’t get a 1099-K – the misreporting rate jumps to 63 percent.
That’s one reason why 1099-K reporting is so important even if total earnings for a year don’t meet the threshold. It’s why I’ve been advocating for TPSOs to send 1099-K forms even when workers don’t meet the threshold. The most recent Joint Committee on Taxation budget estimates indicate that there’s at least $3 billion going unreported. That’s not a massive number yet, but it is rapidly growing as the sharing economy grows.
Sovos: So, the high threshold hurts the Treasury, but what kind of impact does it have on workers themselves?
Caroline Bruckner: I found in my research that many sharing-economy workers don’t know they have to report income and pay taxes even if they don’t receive 1099-K forms. Also, too many of these workers aren’t aware that they are subject to quarterly-estimated payments, so they end up potentially running afoul of the IRS. And adding insult to injury, many of these taxpayers leave money on the table because they also don’t know they can take tax deductions based on their shared economy work to lower their tax bills.
My latest research is considering the Social Security implications. If taxpayers don’t report income, they’re not paying into Social Security for later on down the line. It particularly matters for those workers who are already on the lower end of income. They’re not rich. They do not have a 401k.
Sovos: So, Congress just had a chance to address this issue with the latest tax bill but didn’t. Can you shed some light on what happened there?
Caroline Bruckner: In 2017, Congress was well aware that this was a major reporting loophole. I worked with staff at House Small Business Committee to put together a small-business tax reporting bill, and testified to House Small Business Committee.
The House bill included provisions to align the 1099 reporting thresholds by lowering the 1099-K to threshold to $1,500 and, at the same time, raise the 1099-MISC threshold to $1500. In terms of tax revenue, that’s a wash. You don’t make any extra money from lowering the 1099-K threshold if you raise the 1099-MIS threshold.
In the Senate, John Thune of South Dakota, a Republican, pushed similar legislation to close the 1099-K gap. He actually got his bill included in the original Senate finance bill, but it didn’t stick.
But, in addition to the 1099 reporting changes, Senator Thune also pushed to create a safe harbor for platforms who misclassify gig workers. Parliamentarians in Congress reviewed the proposal and determined that labor law changes for classifying gig workers would have been procedurally problematic and could have thrown a wrench into final passage of the bill.
Ultimately, the Senate Finance Committee pulled Senator Thune’s gig economy proposal from the final tax law. However, he’s not giving up, so we might eventually see a drop in the 1099-K threshold after all.
And it’s not just Senator Thune’s failed provision that represented a missed opportunity. There are still lots of exceptions to tax rules in the sharing economy that are costing the Treasury. For instance, there’s the Masters exemption. Under current tax law, if you rent out your home for a period of less than 14 days per year, you don’t have to report the income for tax purposes. This is definitely something to consider when people rent out their homes for thousands of dollars for less than a couple of weeks for special events like the inauguration in DC or the Super Bowl.
Sovos: Congress dropped the ball on lowering the threshold, then, but what about states? Has there been any movement on state fronts?
Caroline Bruckner: Yes, states are going to start moving to collect missed revenue not being reported by gig economy workers. Massachusetts and Vermont have already lowered their 1099-K thresholds to $600 to meet the 1099-MISC, in direct conflict with federal requirements. Some heavy hitters such as California and New York are considering doing the same thing.
States are losing revenue and are targeting TPSOs, including PayPal. When you get into platforms like PayPal, you get into some really big revenue numbers.
For three decades, Sovos has been helping organizations facilitate tax information reporting in the face of changing regulations. Discover what Sovos can do for 1099 reporting, or contact Sovos for more information.