The gig economy has grown by nearly a quarter of a trillion dollars since 2019.
It is one of the fastest growing sectors of the economy, and it is critical that lawmakers continue to promote gig work as the U.S. recovers from the Covid-19 pandemic. That’s why Congress’s new tax policy affecting the gig economy is so crucial. While the American Rescue Plan Act contains a major improvement by simplifying tax filing for gig workers, which will help them comply with the tax code and close the tax gap, additional reforms like a small standard business deduction (SBD) would help ensure that gig workers are not overtaxed on their income.
The new tax policy attempts to solve the growing problem of how to tax gig economy workers by lowering the de minimis exemption for the 1099-K form from $20,000 and 200 transactions to a sole $600 threshold. The new law means that gig economy workers operating for third-party settlement organizations, including Uber, DoorDash, and eBay, earning more than $600 on a platform will now be sent this tax form that reports their yearly income. Previously, these workers and the IRS would only be sent a 1099-K if they had earned $20,000 in income and had over 200 transactions on one of these online platforms.
The new lower de minimis exemption transforms the way the gig economy is taxed, bringing in billions of dollars in additional tax revenue. It simplifies the tax code and provides workers and the IRS with timely income information, which will increase tax compliance and lower the tax gap—all good things. But it will have the adverse effect of introducing gig workers to the ever-growing complexity of the business tax code. Eighty-five percent of gig workers make less than $500 a month, and many of these Americans will be paying taxes on this income for the first time. Since they lack the experience to know what business deductions they’re eligible for, much of their income will likely be overtaxed. Congress should address this problem by introducing a small standard business deduction to ensure that first-time gig workers’ income is treated fairly compared with the income of more experienced business owners.
The old law placed a huge burden on gig workers, because they had to track their income from these platforms manually and then report it to the IRS if they were under that $20,000 threshold. But in reality, many of these workers simply never reported all of their income in the first place. From 2011-2013, the IRS estimated that about $110 billion annually, or 25% of the tax gap, was due to business owners (independent contractors and gig economy workers included) underreporting their income. Since then, the gap has grown larger as more Americans have begun working in the gig economy. To shield these workers from becoming targets for the IRS, Congress’s reform was necessary.
The new $600 de minimis rule changes the game, as most workers in the gig economy will now be provided with records of the income they make on these online platforms, making it more likely they will report this income and comply with the tax code. This should help achieve one of President Joe Biden’s main tax policy goals of closing the tax gap as well as reducing unintentional tax fraud.
Another benefit of the new threshold is tax simplicity. Prior to this rule, there were different income thresholds for different types of independent contractors to receive 1099 forms. Traditional independent contractors would have their income reported on the 1099-MISC if they made over $600, but independent contractors receiving income from TPSOs would have their income reported on the 1099-K only if they met the $20,000 and 200 transaction exemption. The IRS never produced any formal guidance on what counted as a TPSO, so every platform was left to decide for themselves which form to file. Some used the 1099-MISC rules, others followed the 1099-K rules. The new $600 de minimis rule provides clarity to businesses, as the threshold for both requirements is now the same. It doesn’t matter in practice which form they file. This clarity and efficiency reduces administrative costs.
Some groups have attacked the reform due to concerns that the lowered threshold increases administrative costs for businesses. This concern is likely overblown. It ignores the simplification for businesses by equalizing the income threshold for the 1099-K and 1099-MISC. It also fails to take into account that many platforms already file the 1099-K for some of their independent contractors. All the new thresholds will do is increase the volume of forms they have to file. The benefits of reducing the tax gap, increasing neutrality across the tax code, reducing administrative costs for gig workers, and simplifying the tax code all outweigh any slight increase in administrative costs for businesses who employ these workers.
A valid concern that Congress should consider in future reforms is that the 1099-K form doesn’t take into account whether or not vendors are making money on their sales. For instance, say someone sells old furniture on eBay for $800 that was bought for $1,500 five years ago. Even though they lost $700 on the exchange, they’ll still receive a 1099-K form reporting $800 in income. It is foreseeable that this small seller will forget about the loss and just report this income to the IRS.
To protect small sellers who are likely just reselling some of their old items, Congress should consider raising the threshold to $1,000 for both the 1099-K and 1099-MISC. This was proposed by Sen. John Thune (R-S.D.) and would help ensure that small sellers are not overtaxed on items they are simply reselling for a loss on online platforms.
The largest concern that Congress needs to address, however, is the fact that many TPSO independent contractors will overreport their income by not claiming any business deductions. Since the tax code treats independent contractors as business owners, they can deduct their business expenses. Thus, Uber drivers can deduct the cost of gas and repairs from their tax bill.
However, this is widely unknown to these workers. As University of North Carolina law professor Kathleen Delaney Thomas noted, almost half of gig workers did not know about “any tax deductions, expenses, or credits that could be claimed related to their on-demand platform income.” This means that when these gig workers begin to report more of their income to the IRS, their income will be overtaxed compared with other business owners. This could stifle economic growth by incentivizing gig workers to work less.
This is a problem that Congress needs to address, and Professor Thomas has proposed the best answer: the standard business deduction.
An SBD would work just like the standard deduction for the individual code by allowing small business owners to take this deduction instead of itemizing their business deductions. It could be designed as a flat deduction like the individual code or as a percentage of a business’s gross receipts. A flat deduction would be the simplest for both taxpayers and the IRS and reduce the ever-growing compliance costs of the business tax code.
The SBD would help ensure that independent contractors are aware of the deductions they can take, reduce over-taxation, and treat their income more equally compared with other business owners, who always take their deductions. It would also help solve the basis issue by shielding some income from taxation that could be losses.
It also could help solve the tax gap. While some gig workers are overtaxed, some are undertaxed because they overstate their deductions. For example, it is fairly easy for a DoorDash driver to overstate the miles and amount they spend on gas while driving without being audited.
An SBD would help solve this problem by giving gig workers an easier route to a deduction. Instead of going through the complicated and time-consuming process of itemizing their business deductions, they could (and likely would) just take the SBD.
It would be a win for both tax simplicity and better tax compliance.
An SBD would be a major upgrade to the tax code after Congress made a long overdue reform to the 1099-K reporting system. The new $600 de minimis rule helps neutralize the reporting system between the 1099-K and 1099-MISC, and it will likely increase tax compliance, and reduce administrative costs for gig workers. But with so many gig workers reporting their income for the first time, Congress must take steps to ensure these workers are aware of the deductions they can take. The SBD is the quick fix. It would provide a simple way of reducing workers’ tax burden without them having to go through the complicated process of calculating business expenses.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Travis Nix (@tnix113) is a student of tax law at Georgetown Law. His tax commentary has been featured in Tax Notes, Fox News, National Review, and the Chicago Tribune, among other publications.