The Gig Economy and Taxes

 August 31st, 2018    

The Gig Economy, Independent Contractors, and Taxes

A few decades ago, virtually everyone who was employed was, well, an employee. If you had a job somewhere, it was generally either a full-time or part-time position that involved a permanent spot on your employer’s payroll. Taxes would be deducted from your checks ahead of time, and the rules and regulations that governed employees would apply to you.

For employees and employers alike, this was a fairly straightforward scenario. As an employee, you knew what to expect from your employer in terms of hours, wages, and tax withholding. As an employer, your accountant or accounting department would handle most employees the same way, and there was little question when it came to an employee’s status or how to handle their pay for tax purposes.

Nowadays, though, things have changed. As of 2018, we no longer live in an economy populated by traditional, full time positions. Instead, the United States is quickly shifting from such an economy state to what we would call a “gig economy.”

What is the new gig economy? Does it come along with both good and bad aspects? How has the gig economy changed the ways that companies have to think about taxes?

In this blog post, we’re going to answer all of these questions and more. Below, we’ll cover the following:

  • Defining the gig economy
  • How the gig economy developed
  • Positive and negative aspects of the gig economy
  • What the gig economy means for taxes
  • Independent contractors vs. employees
  • The IRS 20 factor independent contractor test
  • IRS Form SS-8
  • Voluntary Classification Settlement Program (VCSP)

By the end of this article, you’ll have a better sense of how employers can and should determine whether someone is an employee or independent contractor. Understanding this distinction is more important now than ever before. Treating someone as an independent contractor who should be classified as an employee can lead to issues with the IRS, and it’s essential that employers understand the difference.

As we’ll see below, employers who have been incorrectly classifying workers as independent contractors (when they should be classified as employees) have options available to them. One such option is the Voluntary Classification Settlement Program (VCSP), which makes it easier for employers to shift workers from independent contractor status to payroll employees. After we’ve established the differences between independent contractors and employees (and how to perform the 20-factor test to determine which category a specific worker falls into), we’ll learn more about how employers can participate in the VCSP program if needed.

Of course, it’s important to keep in mind that we won’t be able to fully address everything that there is to know about the gig economy, employees, independent contractors, the 20-factor test, IRS Form SS-8, and the Voluntary Classification Settlement Program in a brief blog post. If you’re a CPA or other tax professional who’s looking to learn more about how to assist your clients when it comes to questions related to independent contractor status, or if you want to find out how to make the VCSP program work for your clients, we highly recommend signing up for one of our 2018 tax webinars. Our tax webinars are taught by qualified professionals, and they’re the perfect way to obtain your required 2018 CPE hours before the end of the year. We offer a webinar that specifically covers the topics discussed here, along with more than a dozen other topics. Get your 2018 CPE hours with Basics & Beyond™ webinars, and save yourself the headache and hassle of traveling to in person seminars.

That said, it’s time to learn more about the gig economy, independent contractor status, and taxes. Ready? Let’s get started!

What Is the Gig Economy?

Regardless of what sector of the economy you work in, you’ve likely heard the term “gig economy” tossed around quite a bit in recent years. It’s something that virtually everyone is talking about. But what exactly does it mean?

Simply put, a gig economy is an economic state characterized by a large number of jobs that are temporary, part-time, or otherwise without permanent features. These jobs are often associated with freelancers, sometimes better known by the more technical term “independent contractors.”

In a traditional economic system, most companies employ full time workers. These workers are a part of those companies’ payrolls. The employees have certain duties and obligations to their employer, and vice-versa. It’s also quite common for employees to stay in the same position for years, working to cultivate a long-term relationship with their employer.

The gig economy subverts this traditional system. Rather than staying in one job for many years, freelancers tend to move around from one position to the next. As we’ll see, there are both advantages and disadvantages to this state of affairs.

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Why the Gig Economy?

There’s little doubt that the United States is quickly transitioning to a gig economy type model. As of 2017, there were 57.3 million freelancers in the U.S., representing 36% of the American economy. The current expectation is that the number of freelancers will grow to represent 50.9% of the population of the United States by 2027. That means that in less than 10 years, more than half of Americans will be freelancers rather than full time employees.

How did this situation come about? There are a lot of contributing factors. On the one hand, technology has significantly reduced the need for workers in house. It’s no longer necessary for many tasks to be performed in an actual office setting. Instead, workers can perform their jobs remotely, often from home. This is a common scenario in 2018, with millions of freelancers opting to work from their home office rather than taking on a full-time position with a company that involves being physically present in an office space.

Meanwhile, many employers have been keen to take part in this trend. With the growing number of startup companies, it’s common for businesses to find themselves in a position where they can’t afford to hire a full staff of full time employees. Freelancers and independent contractors offer a less expensive alternative that also involves lower commitment. At the same time, many companies experience seasonal shifts and changing needs when it comes to staffing. Hiring independent contractors is one way of dealing with this challenge. Meanwhile, employers are also provided with a much larger applicant pool as a result of the fact that employees can apply from anywhere. In other words, businesses are no longer limited to the talent pool available in their immediate area.

Positive and Negative Aspects of the Gig Economy

Is the gig economy a good thing or a bad thing? It depends on who you ask, but there are arguments to be made on both sides.

Those who are opposed to the gig economy often complain that it reduces security for workers and undermines traditional economic arrangements. They long for the days when almost everyone could count on a full-time job that came along with health insurance, ancillary benefits, and a retirement plan. They argue that the current state of affairs is bad for workers, and puts the needs of employers first instead.

Meanwhile, those who support the gig economy would point to the fact that it offers greater freedom and flexibility for both workers and employers. Technology has changed the economy, and there’s no going back. Thanks to the increase in people’s ability to work remotely, the gig economy is bound to continue its growth trend. Rather than trying to fight the inevitable, promoters of the gig economy say that we should embrace it for what it is. It gives employers more choices and provides workers with the ability to work from home, both of which are good things.

What Does the Gig Economy Mean for Taxes?

While it may be true that the gig economy can offer more freedom and flexibility to workers and employers alike, there’s one area where it can definitely complicate things. We’re talking, of course, about taxes.

The IRS actually refers to the gig economy as the “sharing economy,” and they’ve even created a section of their website dedicated to it. There are reports that the IRS is stepping up its audit coverage to include more taxpayers working within the gig economy, too. In other words, the IRS is well aware of the growth of the gig economy, and is taking steps to both assist taxpayers in complying with federal tax regulations while also ensuring that the federal government receives the taxes that are due as the results of work performed as part of the gig economy.

As more and more people are willing to work temporary and part time positions, we’ve seen a growth not just in the number of full time freelancers but also in part time workers for services such as Uber and Lyft. When you consider that workers for companies such as these are often considered independent contractors as well, it’s easy to see just how expansive the gig economy has become.

Independent Contractors Vs. Employees

The gig economy has complicated the federal tax landscape considerably. Where in the past it was commonplace to simply include all workers on a company’s payroll, it’s becoming increasingly common instead to simply treat them as independent contractors.

But what exactly is an independent contractor? Generally speaking, an independent contractor is someone who has the right to direct and control how their own tasks are done.

When it was originally enacted, the Social Security Act didn’t actually contain a specifically worded, precise definition of what an “employee” is. As a result, the U.S. Treasury Department put into place a set of regulations that use a common law control test to determine whether a worker is an employee or an independent contractor for federal tax purposes.

Make no mistake: classifying workers properly as either independent contractors or employees is one of the most difficult things to do when it comes to properly interpreting federal tax law. In other words, there’s no quick, easy, cut and dry way to determine whether someone is an independent contractor or not. At the same time, though, doing this correctly is incredibly important. The IRS knows that many businesses intentionally avoid payroll tax responsibilities by incorrectly classifying workers as independent contractors when they should be employees, and the IRS is actively working to find and prevent businesses who engage in this practice from continuing to do so.

If a worker is classified as an employee, their employer is required to do the following:

  • Withhold Federal income tax
  • Pay the employer’s share of FICA tax
  • File a Form W-2 for that worker
  • Provide fringe benefits as required by law
  • Provide the right to continuing health care coverage after termination (COBRA)
  • Comply with requirements related to health care reform

Meanwhile, if an individual is an independent contractor, the employer must simply issue a Form 1099-MISC if the contractor receives more than $600 in compensation. That’s it — there’s nothing else to do. It’s easy to see why this would be attractive for employers, as there are major cost savings involved. Meanwhile, it’s up to the employee to pay self-employment taxes, take care of their own health care coverage, and make estimated tax payments throughout the year.

The IRS 20 Factor Independent Contractor Test

So, how do you determine if someone is an independent contractor or an employee? The IRS uses a 20-factor test, with test questions divided into behavioral, financial, and type of relationship categories.

When conducting the 20-factor test, a business has to ask itself questions like:

  • Does the company control how the worker performs their tasks?
  • Is there worker training involved?
  • Is there a continued relationship between worker and employer?
  • Are full time hours required?
  • Are there set hours involved?
  • How is pay handled?
  • How are discharge and termination handled?

Based on the answers to these questions, a worker may or may not be classified as an independent contractor.

IRS Form SS-8

If you’re still unable to determine how a worker should be classified after going through the steps outlined in the 20 factor IRS test, you can file IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will review the factors involved in the case and present a determination regarding the status of the worker in question.

It can take the IRS upwards of six months to make this determination, so don’t expect a quick reply. However, this can be a useful approach to take if an employer finds themselves regularly hiring the same type of worker again and again, and isn’t sure how to classify them.

Voluntary Classification Settlement Program (VCSP)

If an employer determines that they need to reclassify independent contractors as employees for future tax periods, the IRS has created a program that makes this easier to do and offers some federal employment tax relief. This is known as the Voluntary Classification Settlement Program (VCSP), and participation involves meeting some eligibility requirements. For example, an employer who’s currently undergoing an employment tax audit isn’t eligible to participate in the program.

In exchange for agreeing to pay 10% of the employment tax liability that would have been due for the workers in question in the previous tax year, the employer is released from any liability related to interest and penalties on this amount, and won’t be subjected to an employment tax audit with respect to the workers in question.

2018 CPE Hours

There’s a lot more detail to cover when it comes to VCSP, IRS Form SS-8, and the 20-factor independent contractor test. If you want to learn more about these topics, we highly recommend signing up for one of our 2018 tax webinars. They’re an engaging and affordably way to fulfill your 2018 CPE hour requirements, and you’ll learn about a variety of important topics for tax professionals. Click here to register for a tax webinar now!

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