Blog Essay

Tax Reform for the Gig Economy?

Several weeks ago, President Trump and his “Big Six” tax group rolled out a summary of their proposals for tax reform. Among other reform measures, the plan calls for an increased standard deduction, elimination of many itemized deductions, a switch from seven tax brackets to three tax brackets for individuals, a reduced corporate tax rate of twenty percent, and a reduced maximum tax rate on passthrough businesses of twenty-five percent.

The stated goal of the plan is to “deliver a 21st century tax code” that will, among other things, offer “[t]he simplicity of ‘postcard’ tax filing for the vast majority of Americans” and provide “[t]ax relief for businesses, especially small businesses.”  (The plan also promises to provide tax relief for the middle class, end incentives to move jobs and capital offshore, and close special interest loopholes.)  The goals articulated in the plan are consistent with President Trump’s and other Republicans’ repeated calls for tax reforms that will simplify the code and provide relief for small business owners.

Noticeably absent from the plan, however, is any tax relief aimed specifically at workers in the gig economy. The gig economy (a.k.a. the sharing economy) ­— comprising individuals working for online platform companies like Uber, Airbnb, and TaskRabbit — has experienced rapid growth in recent years, a trend which is expected to continue. The absence of meaningful tax reform for this sector is striking in a plan explicitly aimed at modernizing the tax code, particularly given the extensive and continuing increase in the number of gig workers. One study estimates that the number of individuals working for online platforms, currently around 3.2 million, will more than double to 7.6 million by the year 2020.

Gig workers face a number of challenges under current tax law. Because they are generally treated as independent contractors, rather than employees, they are not entitled to have their income taxes withheld. Instead, gig workers must budget for taxes on their own and make quarterly, estimated income tax payments to the IRS. Additionally, they must pay self-employment taxes, equal to 15.3 percent of their net income, which must also be estimated on a quarterly basis. Employees, by contrast, have their income and employment taxes withheld from their paychecks, and the employer splits the employment tax with the employee (7.65 percent due by each).  Gig workers who don’t understand these rules or who fail to budget properly may find themselves facing year-end tax bills that they can’t afford, as well as possible penalties. And because not all platform income is reported on a Form 1099, workers who don’t keep good records during the tax year may not even be aware of how much taxable income they must report.

Business expenses are also a source of consternation for gig workers. While workers can deduct their business expenses “above the line” (that is, without the kinds of limitations imposed on itemized deductions), claiming these deductions requires meticulous recordkeeping and a working knowledge of the tax law. Yet many gig workers are confused about which expenses are deductible, and even when they understand the rules, tracking and reporting those expenses is burdensome and time consuming.

All of these challenges impose costs on the government that should be of concern to policymakers. Confusion over complicated tax rules, as well as liquidity concerns, likely cause many gig workers to underreport their tax liability, which only adds to the $458 billion tax gap. Noncompliance by gig workers also means that the IRS must expend more resources to audit returns and penalize offenders, as well as to advise and educate confused taxpayers.

The Big Six tax plan does virtually nothing to address any of these issues. While the plan proposes eliminating many, though not all, itemized deductions, such a reform would result in more individuals claiming the standard deduction, which is taken “below the line.” But the majority of Americans already claim the standard deduction, and itemizers tend to be high earners who likely have more resources to spend on tax return preparation. For gig economy workers, the bulk of the complexity on the tax return comes from above-the-line deductions (that is, business expenses), which appear to be largely unaltered by the plan. For gig workers or any small business owner with deductible business expenses, a tax return short enough to fit on a “postcard” would not be an option.

While the plan does propose a maximum twenty-five percent tax rate on passthrough businesses, this reduction would also do little, if anything, to help gig workers. Under the current tax brackets, an unmarried individual must report more than $91,900 of taxable income (after deductions) before a rate higher than twenty-five percent kicks in.  Because most gig workers don’t reach this income threshold, the twenty-five percent rate would not provide an advantage. The proposal, of course, would be a boon for wealthy business owners in the highest (39.6 percent) tax bracket.

Notwithstanding the limitations of the Big Six plan, there have been some positive steps towards tax reform for gig workers in recent months. Notably, Senator Thune’s NEW GIG Act of 2017 (S. 1549) addresses some of the pressing tax issues faced by gig economy workers.  The proposed legislation would require platform companies to issue a Form 1099 to gig workers earning at least $1,000, which is a significant improvement over the current $20,000 threshold for 1099-K reporting that applies to many workers. Such reporting would not only aid IRS enforcement efforts, but would also serve as a form of automated recordkeeping for the workers themselves.

Additionally, the bill would require platform companies to withhold five percent of gig workers’ gross earnings, up to $20,000. Like information reporting, gross receipts withholding would aid in revenue collection from the government’s perspective while significantly easing the compliance burden on the part of gig workers. If all (or most) of workers’ taxes were withheld, they would not need to file quarterly taxes or worry about budgeting for taxes during the year. Surprising year-end tax bills and penalties would be eliminated for many of these taxpayers. While the proposed five percent withholding rate is probably not high enough to fully cover the tax obligations of many gig workers, it is certainly a step in the right direction. An even better approach would be a provision that allows workers the option to elect to have a higher percentage of their earnings withheld.

Another possible simplification measure for gig workers that I have advocated for would be to replace business deductions for low-earning workers with a “standard business deduction,” which would vastly simplify their tax reporting obligations. Rather than having to spend hours tracking and reporting expenses when relatively low dollar amounts of tax are at stake, workers would just claim a flat dollar amount or fixed percentage of their earnings as an above-the-line deduction. If gig workers had all their earnings reported on a Form 1099 and could also claim a standard business deduction, simple “postcard” tax filing would actually be achievable for those taxpayers.

While there are many political obstacles to tax reform, measures like gross receipts withholding and expanded information reporting for gig workers are less controversial. Congress can and should act on those proposals now. Regardless, tax reform that seeks to help truly small business owners while simplifying tax reporting must entail far more than a tax rate reduction aimed at the highest earners.