There has been a lot of attention paid to “gig” economy workers lately, and that includes some scrutiny by state and federal tax authorities. The growing impact to tax revenue as a result of under-reporting of income and minimal payments of self-employment taxes from this ‘new’ sector of American workers has not gone unnoticed. Academic and tax professionals have written articles related to the potential tax gaps as a result of misaligned laws and lack of education related to tax obligations in this industry.
Background
To be clear, “gig” work is not new; musicians and artists to name just a couple of examples have been performing side hustles for a long time. But the rapid growth of this new worker economy is what shapes the news. More Americans seem to be turning towards part-time gigs, and research indicates that technology has likely helped to contribute to what could turn out to be a new U.S. worker classification.
A 2016 study released by the JP Morgan Chase Institute surmised that the online platform economy allows workers and sellers to connect easily, and provides flexibility for people to work when they want. Work can be completed for simple, short-term tasks, and reimbursement occurs electronically. Platforms also exists for participants to sell goods or rent assets using similar flexible technology to execute transactions.
Tax reporting framework
Gig economy workers are non-employees and should receive either Form 1099-MISC or Form 1099-K. When a payer reimburses workers through an electronic platform, the tax law requires a Form 1099-K, rather than Form 1099-MISC, which reveals the income earned from freelance jobs paid during the calendar year.
A disparity exists between the two forms. Non-employee compensation reported on Form 1099-MISC is required when payments aggregate to $600 or more during the calendar year. However, third-party payment settlement organizations (TPSOs) must issue Form 1099-K when payments aggregate to $20K or more during the calendar year – and those monies had to be paid over the course at least 200 transactions to be treated as reportable.
Many gig workers do not make enough money to trigger the Form 1099-K reporting requirement. According to State Tax Notes, an informal survey of gig workers indicated that 88 percent earned less than $15K per year, and another survey indicated earnings of less than $500 per month.
Failing to receive a Form 1099-K creates problems for both the taxpayer and the government. The same State Tax Notes article also indicated that a 2017 report by finder.com estimated 69.8 million Americans participate in the gig economy but do not declare an estimated $214.6 billion to the IRS each year. According to the IRS, 63 percent of taxpayers who do not receive a 1099 form will underreport income, and most do so inadvertently. If they are self-employed, they could also be unknowingly underpaying self-employment taxes, Medicare and Social Security.
States get in on the gig
Over the last two years, a handful of states introduced legislation to align Form 1099-K reporting with Form 1099-MISC in their states and require TPSOs to report Form 1099-K at the $600 threshold.
In 2017, Vermont introduced a bill to eliminate the 200-transaction limit and reduced the reporting threshold to $600. The state also aligned laws related to information reporting penalties for failure to file with these new rules during that same year. Massachusetts followed by passing a nearly identical bill the same year.
Pennsylvania introduced a proposed reporting requirement that would reduce the 1099-K reportable threshold to $5K and eliminate the transaction rule. Earlier this year, Illinois introduced legislation that would move the threshold to $1K and just three transactions per year, and it is moving rapidly through the state legislature.
TIGTA audits IRS
In February, the Treasury Inspector General for Tax Administration (TIGTA) released results of an audit that “was initiated to evaluate the self-employment tax compliance of taxpayers who earn income in the gig economy and assess the IRS’s processes and controls that identify and address noncompliance with self-employment tax requirements.” During that audit, TIGTA discovered that Treasury regulations for reporting Form 1099-K for gig economy workers are insufficient and recommended that the IRS work with the Office of Tax Policy to address the issue. I wrote about the findings in this report earlier this year.
Congress and the side hustle
In early March, H.R. 1625 was introduced as the NEW GIG Act of 2019. This bill essentially establishes a new worker classification separating a gig worker from an independent contractor. This bill also sets forth a proposed 5 percent withholding rate and reporting requirements. S.700 was also introduced in early March with identical text. The Senate Finance Committee is currently reviewing the details, including the withholding and reporting implications associated with these payments.
House Ways and Means Committee Chairman Richard Neal, D-Massachusetts, underscored the underreporting issue when he released the most recent IRS estimates of the tax gap at $460B recently in a hearing to examine taxpayer noncompliance. Kevin Brady, R-Texas, pointed to the underreporting issues in the gig economy as areas of the tax law that Congress should focus on rather than focusing on ramping up IRS enforcement for noncompliance.
The inevitable
Form 1099-K Filers, and especially gig economy payers, should prepare for the pending change to the withholding and reporting requirements associated with Form 1099-K. Understanding the business and tax implications, providing feedback to the IRS during the open comment periods that will come with proposed changes, and planning for the changes within the organization are crucial to staying in compliance.
Following are some points to consider with these proposed regulations –
- Introduction of a new classification of workers. Criteria of what constitutes this new classification could determine whether the recipient receives certain mandatory withholding and reporting rules. How will payers be required to collect information from recipients in order to determine their status?
- Elimination of Form 1099-K and return to Form 1099-MISC. How does this impact payment card transactions, also reported on Form 1099-K but with no reporting thresholds? How will the 1099-MISC be updated to accommodate the clarity of the types of payments (i.e., a new box on the form, updated instructions)?
- Withholding tax. Proposed rate is 5 percent, which is not a rate used in the current withholding tax structure in place with the industry and the IRS. What is the impact to payment systems to implement a new withholding regime? How would policies and procedures need to be updated to accommodate the changes?
- Creation of new Form 1099 for gig economy worker payments. Similar to a W-2 or the old 1099-NEC (non-employee compensation) form, a form specific to payments made to gig economy workers could be created. How would information be collected for purposes of reporting on this form (e.g., Form W-9?)? What would the process for remitting and reconciling withholding taxes entail for this new regime?
- Reduction of the current threshold for Form 1099-K to align with Form 1099-MISC at $600. What would the print and mail costs look like with significantly more forms being sent to recipients? How does compliance risk heighten as a result of filing so many more records with the IRS?
Investment in a modern tax solution
Minimizing the impact of the significant changes ahead may require investment in a modern tax solution. Scalable solutions can ingest multiple sources of transactional data, limiting impacts to already strained IT resources. Technology that can transform source transaction data into tax reportable formats for recipients, the IRS and state tax jurisdictions minimizes manual involvement in preparing the data for reporting.
Automation of IRS compliance validations to the data reduces risk of noncompliance. Producing tax statements that comply with IRS requirements and that are delivered to recipients in a timely manner is imperative to the organizational reputation.
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