Many taxpayers just finished an unusual tax filing season, with pandemic-related relief measures altering their taxable income. For reasons largely unrelated to the pandemic, certain revisions to the tax reporting rules affecting the sharing economy sector also took place over the last few months. This blog post reviews two such changes that have not been extensively discussed and their implications for tax administration and compliance: the comeback of Form 1099-NEC and the reduced reporting threshold of Form 1099-K.
Tax Compliance Issues for Sharing Economy Workers
The growth of the sharing economy has been an ongoing phenomenon that began prior to the pandemic. Throughout 2020, preliminary statistics showed that the number of self-employed workers continued to increase, including sharing economy workers (also known as gig workers) who find work through online intermediaries that use app- or web-based software platforms to match with consumers for goods or services. The common examples of gig economy business models include ride-hailing (Uber and Lyft), home-sharing (Airbnb and VRBO), peer-to-peer sales (eBay and Etsy) and service-based platforms (TaskRabbit and Doordash). Before the pandemic, ride-hailing businesses constituted the largest sector in the sharing economy by number of workers and revenue. However, significant reshuffling took place last year as Uber, Lyft and Airbnb experienced a near absence of demand during the shelter-in-place periods. The reduced traffic was offset by the increased request for food delivery services from companies like Doordash and goods from sites like Etsy or eBay, as people’s increased time at home enabled more online activities.
As the sharing economy has become more prevalent, tax compliance has become a concern for both lawmakers and tax administrators. Because of their self-employed status, sharing economy workers must follow rules similar to those that govern small business owners — a group that generally has more resources to navigate complicated tax rules. Practitioners agree that, considering gig workers usually earn a small amount of income from the platforms to supplement their income or bridge employment, the tax rules are overly burdensome for them.
In addition, a reporting gap between two information returns, Form 1099-MISC and Form 1099-K, has also increasingly generated attention. In general, companies are supposed to issue Form 1099-MISC to nonemployee workers if their annual compensation exceeds $600. A separate Form 1099-K was introduced in 2011 that requires banks, credit card companies and third-party settlement organizations (TPSOs) to report payments to each payee if the aggregate payment exceeds $20,000 and the number of transactions exceeds 200 annually.
The Form 1099-K was put in place to simplify compliance for payment processing entities, before the platform companies’ surge in popularity. However, several platform companies took the position that they are TPSOs and thus qualify for the higher reporting threshold. This creates an obvious reporting threshold discrepancy between Form 1099-MISC and Form 1099-K.
A Department of the Treasury study indicates that the underreporting of income associated with Form 1099-K is a leading cause for noncompliance, costing billions in lost tax revenue. A separate report by the Government Accountability Office corroborates this view. The report indicates that merely 30% of gig workers known by the Internal Revenue Service (IRS) had gross platform-related earnings higher than $5,000, meaning that the current Form 1099-K reporting threshold far exceeds the average gross pay for many sharing economy participants.
For tax year 2020, the IRS requires payers to report nonemployee compensation (NEC) payments that exceed $600 on Form 1099-NEC instead of the traditional Form 1099-MISC. Form 1099-NEC was first used during the Reagan administration in the 1980s, and, as Form 1099-MISC was expanded to include nonemployee compensation reporting in 1983, Form 1099-NEC became duplicative and was no longer needed. Over time, a series of misaligned tax document issuing deadlines led to confusion and potential opportunities for fraud. As a result, the IRS reintroduced Form 1099-NEC after nearly 40 years to ensure consistent issuing deadlines across relevant information reporting documents. The deadline for issuing Form 1099-NEC is January 31.
Although the comeback of Form 1099-NEC is not primarily driven by gig worker tax compliance, it affects many platform companies. Several labor-based sharing economy platforms, including Uber and Doordash, issued Form 1099-NEC instead of Form 1099-MISC to all drivers and Dashers for the 2020 tax year if they received more than $600. However, home-sharing and peer-to-peer sales-based platforms, including Airbnb and Etsy, continued to issue Form 1099-K under the higher threshold except in states where a lower reporting threshold exists (e.g., Vermont and Massachusetts).
Reduced Form 1099-K Reporting Threshold
The American Rescue Plan Act of 2021 passed in March includes a little-noticed provision that reduces the Form 1099-K reporting threshold for TPSOs to $600 regardless of the number of transactions. This provision will take effect next year, and is expected to raise $8.8 billion of tax revenue over the decade between 2022 and 2031.
This provision will not impose equal compliance burdens across sharing economy platforms. Specifically, it will have larger effects on platforms that currently issue Form 1099-K, which primarily include peer-to-peer sales and home-sharing companies like Airbnb, Etsy and eBay. Certain service- and transportation-based companies that have been positioning themselves as TPSOs will also need to get accustomed to this new standard. These companies include Lyft, which has been issuing Form 1099-K for drivers who provide over 200 rides and receive at least $20,000 in ride payments, and Upwork, which has been providing Form 1099-K under a similar threshold.
However, the provision may not have as much impact on ride-sharing or service-based companies that have already started issuing Form 1099-NEC, including Uber, Doordash and Handy. For these companies, the compliance adjustments will be limited to the income streams that are subject to Form 1099-K reporting, potentially payments between platforms and restaurant merchants for food delivery.
From the perspective of sharing economy workers, there is no doubt that more workers will receive tax documents under the reduced threshold. Some practitioners believe the changes will have positive effects on tax compliance. Taxpayers may have failed to report gig income simply because they did not have sufficient documentation on their earnings, and the high reporting threshold of Form 1099-K is the culprit. The reduced threshold will provide information that will help workers to properly follow their tax compliance obligations. Supporters also think the consistent reporting threshold of $600 across forms will simplify compliance for active gig participants.
Opponents argue this change treats gig workers unfairly because they will be paying higher taxes. Affected sharing economy companies also criticize the reduced reporting threshold. They claim the change will deter participation because sellers need to provide Social Security numbers to the platforms for tax purposes, which will negatively affect entrepreneurship. Some companies indicate that they support reducing the Form 1099-K reporting threshold, but not as low as $600.
The issue with the unfairness argument is that, in principle, taxpayers are supposed to report income as long as they receive payments. This reporting obligation is not conditioned on receiving a Form 1099. In other words, some sharing economy workers may indeed pay more taxes under the new rules, but their tax liability does not increase as a result of this provision.
In addition, a reporting threshold that is lower than $20,000 but higher than $600 is likely to continue the existing discrepancy: currently, an Uber driver who earns $600 will receive a Form 1099-NEC and pay taxes accordingly, but Lyft views itself as a TPSO and issues Form 1099-K to drivers. A reporting level that is higher than $600 can certainly be discussed; however, consistency across forms needs to be maintained. Different reporting thresholds between Form 1099-NEC and Form 1099-K will mean two similar ride-hailing companies are subject to different income reporting levels.
The inconsistent reporting thresholds have been an issue for income earned across different sharing economy platforms, and practitioners have advocated for consistency over the last several years. Although the revision is buried in a pandemic relief bill, it is a step in the right direction. However, more can certainly be done to simplify reporting and enhance compliance. For instance, Form 1099 reports gross payments, and taxpayers need to keep records of expenses incurred to reach net taxable income. An optional simplified standard deduction, similar to the current home office expense deduction or standard mileage deduction, may provide significant improvement for taxpayers who earn small amounts of income from infrequent platform work. It may also deter overreporting of business expenses.
For sharing-economy workers who have never received a Form 1099-K, next year may come as a reality check. Although workers do not need to file their 2022 returns until 2023, it is best to develop a plan for compliance early, such as keeping track of business expenses and budgeting for estimated payments in 2022. The IRS can promote taxpayer awareness by posting the new rule on its Sharing Economy Tax Center, using social media, or partnering with platform companies to inform taxpayers early.