Last year’s Tax Cuts and Jobs Act gave some gig workers — usually classified as independent contractors — a tax cut. But the most vexing tax challenges facing these workers are not high rates but convoluted rules and tremendous compliance obstacles that leave them vulnerable to IRS audits and penalties. This post reviews what the tax law did and what it failed to fix before turning to reform proposals.
The Tax Cuts and Jobs Act
Most gig workers are taxed like sole proprietors, or owners of unincorporated businesses. Sole proprietorships, like partnerships and S-corporations, are known as pass-through businesses. Income from pass-throughs was and still is taxed at the individual ordinary income tax rate, the one workers pay on their income. But the new law allows a deduction of up to 20 percent on income from pass-throughs, with some exceptions that are inapplicable to most gig workers. In short, gig workers are now eligible to shave 20 percent off their income before calculating what they owe.
There’s no typical gig worker, so it’s hard to give a sense of how much most will save. But, to take a simplified example, a childless, full-time gig worker earning $25,000 a year would save about $ 450. Because this deduction is regressive, the savings would continue to increase in absolute terms with income until income reaches $157,000; there, the deduction starts to phase out.
For most, the tax savings aren’t huge. Yet the new deduction prompted headlines like The GOP tax bill could create a nation of freelancers and The new tax law creates a huge boon for Uber and Lyft drivers, suggesting that the law had measurably shifted workers’ employee versus independent contractor cost-benefit calculus toward contracting.
Someone should run the numbers for different worker profiles. But, for many, the benefits of becoming a contractor will still pale in comparison to the costs, considering all that workers lose as contractors — coverage by labor standards, a basic safety net (benefits, unemployment insurance, workers’ compensation), anti-discrimination protection, the right to unionize. (Of course, worker classification under the tax code is legally distinct from classification in labor and employment law, but classifications usually converge in practice.)
We should worry about companies leaning on the salience of the impressive-sounding, well-hyped tax cut to manipulate workers into accepting reclassification or misclassification.
Continuing Tax Challenges
Meanwhile, the new law didn’t touch the three biggest tax challenges facing gig workers.
- Withholding. Employees have their income taxes withheld by their employers, but contractors aren’t even eligible for withholding, so gig workers have to calculate and set aside the money they owe in taxes. What’s more, gig workers earning over $1,000 can’t pay the IRS once: they’re required to make quarterly-estimated payments. The complexity of calculating and budgeting for this is one problem; another is that many gig workers aren’t fluent in these requirements, risking penalties for failure to pay or for underpayment.
- Reporting. Companies are often not required to report income to contractors. While employees must get W-2s stating wages and taxes, an astoundingly unworkable set of rules governs income reporting on nonemployees. There’s particular uncertainty surrounding the rules for those paid over multiple, noncash transactions, like Uber and Lyft drivers. Some companies voluntarily provide IRS forms to workers beginning at different income levels, in the form of 1099-MISC or 1099-K, and others provide summaries of earnings in unofficial form. In part because company policies vary and have been in flux, even workers who get a report of their income struggle to understand what they’re getting.
- Business Expenses. Independent contractors can deduct their business expenses. But taking advantage of this deduction requires specialized knowledge of what’s deductible and how, as well as meticulous recordkeeping.
The IRS has clued in to these issues and provides guidance in its “Sharing Economy Tax Center.” A cottage industry also churns out tax advice for gig workers, many of whom also turn to online fora. But clear advice won’t solve the deeper problem, which is that compliance burdens and risks fall so heavily on workers.
A couple of tax reform proposals that remain on the table after the recent law would straightforwardly help.
- Creating a standard business deduction for sole proprietors, modeled after the regular standard deduction, seems like a no-brainer to reduce complexity and lessen record-keeping burdens.
- Senator Sherrod Brown and Representative Ro Khanna proposed an expansion of the Earned Income Tax Credit (EITC), which would help taxpaying workers generally, in or outside the gig economy. Some states don’t currently allow independent workers to use their independent income to qualify for state EITC; California recently changed its rules.
Most companies with gig workers also employ employees and therefore have infrastructure for income reporting and withholding that could be scaled. Yet the withholding and reporting issues remain thorny, in part because of those rules’ relationship to the broader debate about worker classification. The major proposal on the table is the NEW GIG Act, introduced by Senator John Thune and Representative John Rice, which would create a safe harbor for reporting and withholding: If the work relationship satisfied a lax set of criteria indicating independence, then the company would be required to report and withhold. As the official summary puts it:
The safe harbor focuses on three areas that are intended to demonstrate the independence of the service provider . . . based on objective criteria, rather than a subjective facts-and-circumstances analysis:
- The relationship between the parties (e.g., job-by-job arrangement, the service provider incurs his own business expenses, the service provider is not tied to a single service recipient);
- The location of the services or the means by which the services are provided (e.g., the service provider has his own place of business, does not work exclusively at the service provider’s location, provides his own tools and supplies); and
- A written contract (e.g., stating the independent-contractor relationship, acknowledging that the service provider is responsible for his own taxes, providing the service recipient’s reporting and withholding obligations).
As a commentary on this blog pointed out, a redefinition like this in the IRC could spill over into controversies in employment and labor law. And this redefinition is to the benefit of companies — major platforms like Uber and Doordash quickly jumped on board with the legislation. Even a gig-specific classification in the Code that gives away less would ultimately have a similar flaw — smuggling a settlement on a contentious issue of social and economic policy into the technicalities of the tax law.
Instead, we might pursue a narrower fix. As the Taxpayer Advocate has proposed, the IRS could allow safe harbors on a case-by-case basis through voluntary withholding agreements between the IRS and gig companies “in which [the IRS] essentially agrees not to challenge the classification of workers who are a party to such agreements.” This isn’t a long-term solution, but it could provide relief while we wait for a broader settlement on worker classification.
 After deducting the employer-equivalent of the self-employment tax, the worker’s adjusted gross income would be roughly $23,250. The new 20% deduction can be taken by taxpayers who itemize and taxpayers who take the standard deduction. Based on the new standard deduction of $12,000 and the new tax brackets, the worker would owe about $1,350 without the new deduction and would owe about $900 with the new deduction.