If you haven’t yet entered the gig economy, there’s a fairly good likelihood that you will eventually, to earn extra income in retirement or to supplement your regular pay.
More people now drive at least part-time for ride-share services like Uber and Lyft, perform other freelance jobs, sell goods online and even rent out rooms in their homes.
Yet the tax-paying and record-keeping demands, and tax-shaving opportunities, for gig workers are different from what many people are used to as conventional employees, which leads to confusion.
“Besides many ride-share and delivery gig jobs, we are also seeing home health care workers, landscapers and personal assistants,” said Jim Simpson, a Scottsdale-certified public accountant who helps prepare tax returns for free under the Volunteer Income Tax Assistance and Tax Counseling for the Elderly programs sanctioned by the Internal Revenue Service.
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In many cases, “We have to educate (these taxpayers) on allowable deductions and send them home to reconstruct records,” he said.
In addition to confusion about allowable deductions, some gig workers aren’t fully reporting their income. The IRS is noticing this as it attempts to narrow the nation’s “tax gap” or difference between what taxpayers owe and actually pay.
“The gig economy has … emerged and grown considerably, with thousands of new taxpayers each year being responsible for self-employment taxes,” noted the Treasury Inspector General for Tax Administration, in a 2019 report. “It is likely that self-employment tax underreporting will continue to be a growing problem if not addressed.”
Confusion over job status
Part of the problem is that some people might not know whether they should be classified as independent gig contractors or actual employees.
“Unfortunately, there is no universally accepted definition of the range of activities that fall into the gig economy or who should be counted as a gig worker,” said the Treasury Inspector General.
One general rule is that a person is an independent contractor, and possible gig worker, unless the party paying for his or her services has the right to direct or control when and how a job is done. For example, if the party gives detailed instructions, requires the hiring of certain assistants or demands that supplies be bought from a particular vendor, that would indicate an employer/employee relationship.
But confusion arises, Simpson said, especially when it comes to who pays the taxes on Social Security and Medicare plus unemployment insurance and perhaps other costs.
IRS Publication 1779 addresses these distinctions in more detail.
Apps help, to a point
Various digital platforms, through cellphone apps, have made it easier for workers to connect with customers, expanding gig opportunities. However, these digital businesses typically don’t withhold taxes for workers.
The lack of withholding and issuance of personalized reports such as Forms 1099 “creates a more complicated tax situation for individuals who, in many cases, may not understand the tax obligations of their activities, such as the possible obligation to pay self-employment tax,” said the Treasury Inspector General report.
“If these taxpayers are used to traditional employment arrangements and are only participating in the gig economy because it is an easy way to earn extra income, they may be unaware of, or confused by, all of the tax requirements for self-employed individuals,” the report continued.
The IRS has found that compliance is more than twice as likely when workers receive reports like 1099s and have money withheld.
Assume it’s all taxable
One rule is clear: Income earned from gig jobs usually is taxable, even if the jobs are part-time, temporary or supplementary to your regular work. That includes income paid in cash, property, goods or virtual currency — not just by check or credit card.
“You must report all income on your tax return, even if you don’t receive Forms 1099 from the businesses that pay you,” the IRS said.
Self-employment taxes, for Social Security and Medicare, also apply.
But receiving a form doesn’t always tell the whole story. Simpson said he encounters many individuals who have received 1099s for miscellaneous income but who are actually employees, in which case the employer “should have withheld taxes and paid half (of the person’s) Social Security taxes,” he said.
Collect needed records
The IRS recommends that gig workers collect records and receipts throughout the year, as this can help track income along with deductible expenses.
As possible deductions, “Gig workers should think of every dollar they spend that helps them generate income,” said Simpson. This includes tools, office supplies, business courses and apps they purchase to conduct business, such as apps that track mileage.
“Keeping track of miles is one of the most difficult tasks for gig workers, but there are a multitude of apps that can help them,” Simpson said, adding that mileage is one of the key deductions that the IRS scrutinizes.
Not keeping contemporaneous records of mileage, meals and other travel costs as they occur is what gets some gig workers in trouble, agreed Dave Du Val, chief customer advocacy officer at TaxAudit.com.
More deduction opportunities
The bright part is that gig workers have an opportunity to deduct all sorts of expenses that they hadn’t thought much about. For ride-share drivers, the outlays might include those for car washes, bottled water for riders, new passenger mats, increased insurance expenses, parking fees, tolls and even cellphone bills.
People who rent out a room in their homes also face reporting requirements with which they might be unfamiliar. In addition to declaring rental income, landlords might be able to deduct a portion of costs that aren’t deductible for personal use, such as utilities and maintenance.
The flip side is that people who rent rooms have an obligation to depreciate a portion of their homes, with the extra complexities that entails. They also have an obligation to rent at fair value, which can pose problems for those offering a discount to family members or friends, Du Val said.
One more note: On home or room rentals of 14 days or fewer per year, you don’t report income or take deductions.
Prepare for tax payments
If you earn money from gig work, you might need to pay quarterly estimated taxes. The IRS recommends using Form 1040-ES, to make these payments.
Alternatively, if you do gig work as a supplement to your regular job as an employee, you could simply withhold larger amounts from your paychecks to avoid making estimated payments, the IRS added.
When filing a return as a self-employed independent contractor, you likely will need to use Form 1040 and Schedule SE (for self-employment taxes). In addition, you likely would file either Schedule C, showing the profit or loss from a sole-proprietorship business, or the simplified Schedule C-EZ, which can be used if you have a net profit.
The IRS historically has focused audit attention on people filing Schedule C, and that scrutiny could continue for many gig workers. The big audit risk is underreporting income, yet deductions can pose problems too if they seem excessive, especially in relation to the income generated, Du Val warned.
The IRS has a gig economy tax center at irs.gov. Publication 5369, dealing with gig workers, which could prove helpful.
Reach Wiles at [email protected] or 602-444-8616.