Taxes in the Gig Economy

November 22, 2017 : Gil Charney

Gig workers are nothing new – contractors, laborers, musicians, etc. – have been working their crafts for centuries, going from job-to-job or client-to-client to make a living. Individual craftsmen and small shops gave rise to industrialization and the corporate employer in the 19th and 20th centuries.

Changes in terms of how we approach daily work are not over. Driver-less cars, artificial intelligence, and other new forms of technology will continue to change the labor market, and our society as well. However, during the last 35 years or so, technology has been the big boom in the labor universe.

The first wave of the big boom was a shift in labor from manufacturing to the service sector. Then, within the last 10 years, there has been another boom – a shift from the corporation to the individual as a service provider. This shift marked the introduction of gig economy jobs.

 

Filing Taxes as an Independent Contractor

Despite all these astronomical changes, one thing that hasn’t changed is how workers’ income is taxed. All  workers – employees and gig workers alike – must pay tax throughout the year using our “pay as you go” system of taxation. Employees have the convenience of an employer who withholds and remits taxes to the IRS, state, and local taxing authorities.

Gig workers must pay their own taxes more or less evenly in four installments using Form 1040-ES (Estimated Taxes for Individuals). The first payment for the year is due on April 15, the second on June 15, the third on September 15, and the final payment on January 15 of the following year.

TIGTA, the Treasury Inspector General for Tax Administration, has reported a 33% increase, between 2007 and 2016, in the number of penalties assessed for tax underpayments. The jury is out as to the reasons for such a large increase, but these are among the most likely:

  • the growth in newly retired employees who may not realize that their pension, investment, and/or social security income have no taxes withheld,
  • economic growth and higher returns on investments (especially after the Great Recession of 2008-2009) that generated higher dividend and capital gain distributions, with no associated tax withholding,
  • the growing gig, or sharing, economy, where an increasing number of taxpayers work fully, or part-time, with no taxes being withheld from their earnings.

 

Penalties and Payments

The penalty for not paying your quarterly income taxes when due can be annoying or downright painful, depending on how much you owe and how late you are in making the payment. And even if you have a refund coming when you file, you may still have an underpayment penalty if you’re late with your estimated payments!

The best course of action is to simply pay on time and avoid the penalty altogether. Here’s how you do that: every quarter, estimate your tax liability.

This is easier said than done, and the calculations are well beyond the scope of this article. However, this is not your expected refund or balance due, but how much you expect your full-year tax liability to be. This value will appear on your Form 1040, line 63 (you can’t use Form 1040A or 1040EZ if you have self-employment income).

 

Safe Harbors

There are two “safe harbors” from underpayment tax penalty. That is, if you pay a certain amount, you will not be assessed the penalty. The first safe harbor is to pay 90% of your current year tax liability. Of course, calculating the 90% part is easy; as mentioned above, estimating the full year tax liability can be challenging, depending on how complicated your taxes are, so you may want to visit a tax professional for help with that.

The second safe harbor to avoid the underpayment penalty is to pay 100% of last year’s tax. Nothing complicated about that – no calculations or estimates required! This can be appealing to gig workers and others whose income fluctuates. However, if last year’s tax was a lot higher than this year’s will be, you’ll have overpaid your estimated taxes. Of course, you’ll get the excess back when you file your tax return, but in the meantime, your budget may already be pinched.

If you find yourself pulling hair as you navigate the world of gig economy taxes, feel free to chat with your neighborhood H&R Block tax professional.

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Gil Charney

Gil is the Director of Tax Law and Policy Analysis for The Tax Institute at H&R Block.