The Internal Revenue Service (IRS) defines the gig economy as a labor market that’s based on flexible, temporary, or freelance jobs where an individual earns income by providing on-demand work, services, or goods (2021 IRS Virtual Nationwide Tax Forum Webinar on Gig Economy, August 3, 2021). Today’s gig worker is yesterday’s freelancer or independent contractor. The number of individuals participating in the gig economy is growing. According to Small Business Trends, the gig economy grew by 33% in 2020, expanding 8.25 times faster than the U.S. economy as a whole, and 34% of U.S. workers are now involved in the gig economy.
The motivation for this career path is flexibility—choosing when and where to work—and as a source of extra money, such as when used as a source of a second job. The disadvantage is the lack of a steady income stream and employer-sponsored benefits.
The IRS recognizes the gig economy to include rideshare services, delivery services, renting space and properties, selling goods online, and on-demand tasks or freelance work. Other services that fall under this category include individuals performing editing services, creating blogs, writing computer code, and buying and reselling items online, to name a few.
As a result of the growth of this area, the IRS is increasingly interested in the reporting, or compliance, of the income earned by the gig worker. An individual performing services as a gig worker should receive a Form W-2 (Wage and Tax Statement), Form 1099-K (Payment Card and Third Party Network Transactions), Form 1099-MISC (Miscellaneous Income), or Form 1099-NEC (Nonemployee Compensation) from the organization paying for the services rendered. Requiring companies to issue these forms to gig workers is seen to increase voluntary tax compliance. Form 1099-K needs to be issued regardless of the annual payment made to the gig worker.
The amount listed on these forms includes payments made in cash, property, goods, or virtual currency. But even if the paying company doesn’t provide the forms to its gig workers, the workers are still responsible for reporting the income as compensation on their tax returns.
Payment in virtual currency is particularly interesting because Form 1040 (U.S. Individual Income Tax Return) and Form 1040-SR (U.S. Tax Return for Seniors) have been modified to include a checkbox for taxpayers to indicate if they had any virtual currency transactions during the tax year. Thus, failing to acknowledge such a transaction (i.e., checking the “no” box) could lead to penalties for the taxpayer and potentially the tax preparer for failing to perform due diligence.
CLASSIFYING GIG WORKERS
The reporting of the income by a gig worker raises other issues. Is the gig worker a hobbyist, independent worker, or an employee? The classification makes a difference.
If the individual is a hobbyist, the income would be reported on Form 1040 as other income. The disadvantage to this classification is that the hobbyist can’t claim any expenses against the income. Beginning in 2018, the Tax Cuts and Jobs Act of 2017 eliminated all miscellaneous deductions that are subject to the 2% floor. As a result, the hobbyist must pay any applicable federal and state income taxes on 100% of the income.
If the individual is instead classified as an independent worker or self-employed, the income must be reported on Form 1040, Schedule C, which allows the gig worker to write off the expenses associated with the business. This will require documentation to support any business expenses, but it will reduce the taxable income earned from being a gig worker. In addition, the individual can reduce taxable income even further by setting up a qualified retirement plan—a 401(k) or Savings Incentive Match Plan for Employees (SIMPLE IRA) plan—and thereby take advantage of the credit for small employer pension plan start-up costs. But being self-employed or an independent contractor requires the individual to file estimated tax returns (or potentially get hit with tax penalties due to underpayment) and pay self-employment taxes. Furthermore, if the individual doesn’t have insurance (e.g., as part of family coverage through a plan from a spouse’s employer), then he or she needs to secure coverage.
Gig workers haven’t gone unnoticed by other parts of the U.S. federal government. During a news conference on April 2, 2021, U.S. Secretary of Labor Marty Walsh raised the concern that many of these workers should be classified as employees to receive work benefits and not as independent contractors where they wouldn’t receive these benefits. This represents a potential shift in policy from the previous administration, so companies will need to keep an eye on this issue.
The current test to determine if a worker should be classified as an “independent contractor” is the Department of Labor’s “economic realities” test. A worker is determined to be an independent contractor based on the following:
- The extent to which the services rendered are an integral part of the principal’s business;
- The permanency of the relationship between the worker and the business;
- The amount of the alleged contractor’s investment in facilities and equipment;
- The nature and degree of control by the principal;
- The alleged contractor’s opportunities for profit and loss;
- The amount of initiative, judgment, or foresight in open-market competition with others, required for the success of the claimed independent contractor; and
- The degree of independent business organization and operation.
Individuals classified as employees would receive income that will be reported on Form W-2 and, like most workers, would include the amount on their Form 1040. The advantage of being classified as employees is that gig workers will be eligible for benefits offered by the employer.
The number of gig workers has increased over time and is expected to increase even further, especially as younger workers enter the workforce. For those who are gig workers, the importance is in reporting their income properly so that it can be taxed correctly. For companies that use gig workers, classifying the workers properly is critical, as is keeping track of the potential costs should those that work for them end up being treated as employees instead of independent contractors.
© 2022 A.P. Curatola