2018 Brings Massive Tax Changes for the Gig Economy

by Peter Quince on 2018-01-08 11:33am

 

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It’s already exploding – the “gig economy” – growing from fewer than 5% of workers in 2007 to 34% in 2017 (according to Intuit, the company that offers the leading tax-preparation software). And then along comes the Tax Cuts and Jobs Bill, a massive tax overhaul passed by Congress and signed by President Trump in December 2017 that seems likely to expand this sector of our economy even more.

Who are gig economy workers? Also known as “on-demand” or “contingent employees”, the term originally applied to independent contractors who would go from one job to another (usually of the same type, such as carpentry, etc.) or those able to work from home by way of telecommuting, but has been extended to refer to all those who earn money through web applications that connect them to each customer – which the IRS refers to as the “sharing economy”. Since these workers can opt in or out of the system, they consider this to be akin to the “gigs” musicians get. Estimates are that over half of workers who qualify in this category are under age 30, with most of the rest (about 1/3 of all gig employees) over 50. Retirees, in particular, are increasingly looking to the gig economy to supplement retirement earnings. A majority of these people (over 2/3) say they’ve chosen to work this way, and were not doing it because they couldn’t find any other work.

The gig economy is especially vibrant in major cities, with its fastest growth in recent years in Austin, TX; San Francisco; Portland, OR; San Jose; and Seattle.

Most of those in the gig economy don’t rely on it for all of their income. Many may, in fact, also have full-time jobs. Statistics are hard to come by to clarify how many gig workers are also employed full or part-time, but estimates are that as many as two-thirds use the gig economy to supplement income from employment. This mixture of traditional and gig economy sources of income can make filing taxes confusing and lead to myriad errors.

A related source of income applies to those who rent out a portion of their home (or the entire home for a short term) through a web application or those who earn money by selling goods online through eBay or other similar portals.

Pass-Through Changes & the Gig Economy

I’m not sure that when Congress passed the recent tax overhaul, they gave much thought to the well-being of gig economy workers, but they DID address “pass-through” businesses. As some of you may already know, a “pass-through” business is one where business earnings are passed through to the proprietor’s personal income taxes, a method overwhelmingly used by small businesses, especially those with a sole proprietor who is also the sole employee. The gig economy is 99.9% (or more) a “pass-through” arrangement.

Now. the December 2017 Tax Cuts and Jobs Bill runs over 1,000 pages and underwent so many changes during its final stages that it’s not always clear what it attempts to do. For example, an earlier version defined anyone who made money through the sharing economy as an employee, and created a withholding of 5% to be deducted by the company (Uber, Air BnB, etc), but this didn’t make it to the final version. Corporate taxes were significantly cut and there was initially discussion of taxing “pass-through” businesses at the same rates.

The final version instead gave a 20% deduction on “pass-through” income before calculating tax liability (up to a threshold of $157,500 and twice that amount or $315,000 in the case of a joint return). As stated in the Bill:

For taxable years beginning after December 31, 2017 and before January 1, 2026, an individual taxpayer generally may deduct 20 percent of qualified business income from a partnership, S corporation, or sole proprietorship, as well as 20 percent of aggregate qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income. Special rules apply to specified agricultural or horticultural cooperatives permitting the cooperative a deduction.

Qualified business income means net income, after deducting expenses. For example, a pass-through with $50,000 net income would be taxed on $40,000, which (at a marginal tax rate of 12%) Amounts to a $1,200 reduction in tax liability.

Other Deductions for Gig Economy Pass-Through Business

A rumor has been spreading that the December 2017 tax bill was going to cancel a lot of deductions previously allowed, such as mileage, property taxes, etc. Although some deductions have been eliminated or cut back, the deductions critical to the gig economy are largely retained.

And these deductions are hugely important. Since working in the gig economy exposes that person to self-employment taxes, which are double those of the FICA deductions taken from an employee’s wages (since there is no employer contribution for half the amount), it’s vital that anyone working in the gig economy take every deduction to which they’re entitled. Some may be small, such as deducting the cost of heating a home divided by the percentage of the home set aside as an Air BnB, divided by the number of days the space was rented as a ratio of the full year. This particular deduction may end up being only $20, but they all add up and any deduction taken reduces that 15.3% bite in self-employment taxes.

Other deductions can be massive. For example, a full-time rideshare driver can easily rack up 50,000 business miles a year with each business mile granted a $0.535 cent deduction, which translates into a $26,759 deduction for business miles at the end of the year.

Be prepared to justify any business expense claimed; these days there are numerous “apps” (such as MileIQ) available for help those in the gig economy keep track of mileage, receipts, etc. Beware, as well, that the total amount of charge card transactions for a sharing economy worker, as reported to the IRS, may include the portion deducted by the company as their share. Be careful not to OVER-report income but deduct any fees or other charges against that amount before filing.

What if It’s a Side Job?

As noted above, many in the gig economy also have traditional jobs where their income is reported on W-2s and taxes withheld.

It’s fairly straight-forward to report self-employment income on Schedule C and then enter the net income from that form onto the 1099A along with income from employment.

The difficulty may come with regard to paying estimated taxes. Since these people are used to taxes being withheld, they may be unaware or unprepared to pay an amount on top of that to cover anticipated self-employment taxes plus the additional taxes due on the additional income. Since the tax liability would depend on the total both of self-employment and standard employment income, it’s often hard to project tax liability. The IRS offers a “safe harbor” (i.e., no penalties for underpayment) if the estimated taxes paid amount to at least 90% of the eventual amount owed or 100% of what was paid in the prior year (a more easily calculated target).

And Then There’s the Standard Deduction

Previously, the Standard Deduction was $6,500 for individual/single people. Now it will be $12,000 (and more than that for joint filers).

This deduction is taken on the 1099A form, so it applies to all income. Remember, however, that this standard deduction is applied AFTER the self-employment tax has already been calculated. In other words, the taxpayer pays self-employment taxes (15.3%) on the total of business income as derived on Schedule C, then can either itemize deductions or take the standard deduction for personal expenditures on 1099A.

Reporting Income

This may be the most complex part of taxes in the gig economy.

Generally, gig economy income is reported on a 1099-MISC, which is the traditional way that self-employment of $600 or more in any given year was reported. Some gig economy workers may assume that any amount not reported on a 1099-MISC doesn’t need to be listed as income, but it’s best to assume that the IRS has been informed of the income whether or not the taxpayer is aware of receiving a 1099-MISC in the mail.

The other reporting requirement is when credit card transactions exceed $20,000 or 200 in number in any given year, which is reported on a 1099-K. As noted above, be aware that this total may not reflect the deductions for fees, etc., to which the taxpayer is entitled.

Conclusion

The gig economy is expected to continue its rapid growth, perhaps spurred on even further by the December 2017 tax overhaul.

Since many who engage in this sector of the economy are either unfamiliar with tax preparation for a business (for example, retirees who were employees for their entire working lives) or young and new to filing returns, they are likely to be ill-equipped to include all income, find all legitimate deductions, make quarterly estimated tax payments, or know HOW to file the correct forms. According to the IRS, the number of notices sent out asking taxpayers to justify a discrepancy in reported income has increased 33% in recent years, which may require the filing of an amended form, adding another level of confusion to an already overwhelmed taxpayer.

If you’re a tax preparer, be prepared for a record number of gig economy workers seeking your help in 2018 and for years to come.

 

Peter Quince has been making his living as a professional writer since 1978, most recently as a contributor with At Your Pace Online, an innovative online education company that offers pre-license and continuing education for tax preparers, as well as for professionals in real estate, insurance, plumbing, electrical, HVAC, mortgage loan origination, and water operator fields.