A new report, required by Congress as part of the extra $80 billion it gave the IRS, laid out what it would take for the IRS to develop and run a free, direct e-file tax return system. While both the report and a third-party analysis presented a frank assessment of the challenges that the system, called Direct File, would pose, more work needs to be done to ensure that whatever is adopted reflects the reality of how taxpayers earn income outside of traditional employment and pay taxes.
This is particularly important for low-income taxpayers, who often work multiple jobs to make ends meet and may have more than just W-2 income.
Specifically, private sector research shows that at least 60 million Americans are freelancing, which is about 39% of the US workforce. This independent workforce is a trend that has been growing consistently and includes workers who do full-time and part-time freelancing as well as the occasional side gig. In fact, the number of people engaging in occasional side hustles tripled since 2015 to more than 31.9 million today.
While many of these workers still have full-time traditional jobs with withholding done by their employers, the income they have from independent work presents tax filing challenges for the Direct File system not contemplated in the IRS Report.
I once did a return for a woman who had less than $29,000 in adjusted gross income, and her return was more than 50 pages. It wasn’t the federal return—it was the state returns she had to file, having done gigs in California, New York, and Maryland. She was a Washington, D.C. resident. That kind of complexity routinely impacts folks who work in multiple states.
Taxpayers in the independent workforce may be required to pay self-employment tax on their earnings in the form of quarterly estimated payments. In general, quarterly estimated payments are required when a taxpayer is expected to owe at least $1,000 of tax not subject to withholding, and often times, it’s self-employment tax—Social Security and Medicare tax owed on earned income not subject to withholding—not income tax that triggers the quarterly estimated filings for low-income taxpayers. Failing to make these quarterly tax payments can result in penalties and can come as a surprise when taxpayers go to file their return in April.
Many taxpayers aren’t aware of these compliance requirements. Recently, American University Kogod Tax Policy Center worked with Public Private Strategies Institute to survey small business owners and independent workers to better understand the small business tax literacy gap. That survey found that one-third of respondents didn’t know whether they needed to pay quarterly estimated taxes on their earnings, and one-quarter of respondents didn’t know how to pay their taxes. This is a persistent problem for the growing independent workforce, many of whom may not have set aside money to pay tax on their earnings.
The IRS Report did include information on whether taxpayers would like a system that directly incorporated information from a Form 1099 from an employer. However, for many taxpayers, by the time a Form 1099 is filed and sent, they’ve already missed deadlines for quarterly estimated payments. And that’s even assuming the taxpayer receives a Form 1099 at all. The US Government Accountability Office and academic research show that millions of taxpayers receive no information reporting from the companies that hire them.
While critics of the IRS report have been quick to point out that options for a free electronic filing do exist, the National Taxpayer Advocate has argued that these e-file programs are underused and fail to meet expectations, causing unnecessary barriers and costs for taxpayers.
There’s no question that the current tax system is costing taxpayers to comply, particularly for folks in the independent workforce. In fact, 87% of respondents in the American University survey spent money hiring preparers or buying software to do their taxes.
The question remains whether the system can reflect the tax reality of how people work. A Direct File system not designed to facilitate the tax compliance of the growing gig workforce ultimately could result in more, rather than fewer, problems for taxpayers.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Caroline Bruckner is a tax professor at American University Kogod School of Business and is the managing director of the non-partisan Kogod Tax Policy Center.
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