December 15, 2021
By Patrick Crosby, Tax Supervisor
The Rise of the Gig Economy
With the steadily increasing cost of living, a dramatic shift to remote work arrangements, and advances in digital-based technology, many Americans are turning to gig work to earn supplemental income. For some, it has become their main source of income. The IRS defines the gig economy as activity where people earn income by providing on-demand work, services, or goods. Common examples of gig economy activities include providing ride sharing services (Uber), selling goods online (Etsy), providing delivery services (DoorDash), renting out property (Airbnb), and providing creative or professional services (Upwork), to name a few. Gig work is characterized by alternative, short-term work relationships, often achieved through digital platforms like an app or a website.
Given the flexible nature of gig work and the rapidly expanding demand for gig economy services, it’s not difficult to see why so many Americans are signing up. The increasing prevalence of gig work has clear implications for the U.S. economy, however the tax implications associated with gig work are more obscure. In this article, we will examine the tax regulations and reporting requirements applicable to gig workers and provide some best practices to help gig workers prepare for tax season.
Self-Employment Tax Considerations
Traditional employees generally have payroll taxes withheld by their employers, and their annual wages and tax withholding amounts are reported via a W-2 wage statement. By contrast, most gig workers are classified as self-employed for tax purposes, and as such they are personally responsible for making their tax payments. Gig workers are required to report all earnings from self-employment business activities on their federal income tax returns if net earnings from said activities exceed $400 in total for the year. This is true regardless of payment method – whether by check, cash, payment app (think Venmo or PayPal), or cryptocurrency – even if a 1099 tax form is not received.
Self-employment status ushers in a whole new set of tax rules, requirements, and, fortunately, benefits, including the right to claim business deductions and opportunities to save for retirement. Gig workers, as self-employed individuals, report their gross income and related business expenses on Schedule C, the Profit or Loss from Business (Sole Proprietorship) form. Legitimate business expenses can be deducted against gross self-employment income, including but not limited to, the cost of supplies, travel expenses, commissions and fees, postage and shipping costs, auto expenses (if the vehicle is used for business purposes), taxes and licenses, and business insurance. The home office deduction is also available to those who use an area of their primary residence exclusively for business purposes.
After accounting for all legitimate business expenses, net self-employment earnings are subject to the self-employment tax (calculated on Schedule SE). Traditional W-2 employees typically pay 6.2% of their wages in Social Security taxes and 1.45% in Medicare taxes, while their employers pay an equal amount. Self-employed individuals, on the other hand, are on the hook for the entire amount – 12.4% to Social Security and 2.9% to Medicare – for a total self-employment tax rate of 15.3%. A deduction for one-half of the total self-employment tax is permitted against gross income when determining AGI and is reported on Schedule 1 (Form 1040) of the federal income tax return.
Gig Work: Best Practices
Above all else, a sound recordkeeping system is key. Gig workers should keep all receipts and document all expenses to substantiate business income and deductions come filing time. If a personal auto is used for business purposes, keep a log of all miles driven. Setting up a separate bank account for your business and using a separate credit card for business expenses makes tracking easier. Depending on the size of your business, investing in bookkeeping software such as QuickBooks may be worthwhile.
You may want to consider establishing a separate business name and obtaining an Employer Identification Number (EIN) depending on the scale of your gig work activities. Doing so can bolster your marketing efforts while also providing privacy protection. If your gig work activities involve making payments to vendors or subcontractors, make sure you are aware of all 1099 filing requirements. Generally, filing a 1099-NEC or 1099-MISC is required when payments exceeding $600 are made throughout the year to a non-corporate individual or entity for services performed. Additional tax filings, such as personal property returns and annual state reports, may be necessary if your business holds fixed assets or requires state registration and licensing.
Estimated Tax Payments and Other Considerations
Gig workers should be aware of estimated tax payment obligations if they want to avoid underpayment penalties and interest. Self-employed taxpayers do not have taxes automatically withheld from their paycheck like traditional W-2 employees. As such, quarterly estimated tax payments may be required based on the filer’s periodic income. These estimated tax payments are due on the 15th of April, June, September, and January (of the following year). The IRS provides a safe harbor rule – underpayment penalties and interest may not be imposed if the total amount of tax withholding, credits and estimated tax payments made in the current year equal at least (1) 90% of the current year estimated tax liability, or (2) 100% of the prior year tax liability (110% for high earners). Similarly, most states also require quarterly estimated tax payments.
Gig workers may be eligible to claim the qualified business income (QBI) deduction, a provision enacted as part of the Tax Cuts and Jobs Act in December 2017 which allows eligible taxpayers to deduct up to 20% of their qualified business income (subject to certain AGI limitations and business specifications). The QBI deduction is taken on the federal income tax return when determining taxable income and reported on form 8995.
Because gig workers are typically classified as self-employed for tax purposes, they do not receive regular employee benefits such as access to employer-sponsored retirement and health plans. However, they can still invest for retirement through traditional pre-tax, ROTH, and SEP IRA accounts. For 2022, 2021, 2020, and 2019, the annual contribution limit for the traditional IRAs and ROTH IRAs is $6,000 ($7,000 if age 50 or older). For SEP IRA accounts, you can contribute up to 25% of your net earnings from self-employment (not including contributions for yourself) up to a maximum of $61,000 for 2022 ($58,000 for 2021 and $57,000 for 2020). Gig workers should also be aware of the self-employed health insurance deduction which allows self-employed taxpayers to deduct up to 100% of their health insurance premiums (including dental and long-term care premiums) for themselves, their spouses, and their dependents. These self-employed retirement and health insurance deductions are reported on Schedule 1 (Form 1040) of the federal income tax return and are taken against gross income when determining AGI.
Online Resources and Next Steps
For more information on gig economy taxes and best practices, visit the IRS’ Gig Economy Tax Center. For more specific tax guidance, contact your tax provider or submit a question to the GRF CPAs & Advisors tax team.
For more in-depth individual and business planning, contact your CPA or Jennifer Galstad-Lee CPA, Tax Manager, GRF CPAs & Advisors at firstname.lastname@example.org.
Jennifer Galstad-Lee, CPA, JD
GRF CPAs & Advisors