Nobody misses a properly functioning tax information reporting and withholding system until they do. In a recent report dated February 14, 2019, the Treasury Inspector General for Tax Administration (an independent auditing arm within Treasury that has investigative oversight over the IRS, called TIGTA for short) bemoaned the state of tax compliance for self-employment taxes that should be paid by individuals partaking in the fruits of the gig economy. There were a number of culprits identified in the report, but one stands out: tax information reporting. To be more specific, gaps in reporting under an often-misunderstood and relative newcomer to the Form 1099 series, Form 1099-K.
The TIGTA report, titled “Expansion of the Gig Economy Warrants Focus on Improving Self-Employment Tax Compliance,” focuses principally on the underpayment of self-employment taxes (Social Security and Medicare taxes) by gig economy workers. Think Uber driver or Tasker running errands on TaskRabbit. The report provides recommendations on how the IRS can improve processes to reduce the tax gap – that gap between what taxpayers owe and what they are reporting and paying to the IRS. (For self-employment taxes, that gap by the way is estimated to be some $69 billion or approximately 15% of what is believed to be the overall tax gap, which one supposes explains TIGTA’s interest.) But the report has much broader resonance.
First, if nothing else, the TIGTA report highlights the critical role that information reporting plays in our tax system. These few sentences are from the TIGTA report:
Thirty-seven percent compliance without information reporting. That number likely startles even those who work and breathe information reporting.
But how do gig workers and Form 1099-K reporting come into play? And why should we care?
Workers in the gig economy (sometimes called the on-demand or sharing economy) occupy a unique space between employees and traditional independent contractors. These workers generally provide services through online platforms that link individuals that can provide certain goods or services with others who require such goods and services. TIGTA specifically mentions online platforms such as Uber, Lyft, Etsy, Handy, and TaskRabbit. An Uber driver’s customer is the passenger, but Uber stands in between to facilitate and payment is processed through the online platform. These platforms create novel work arrangements and give rise to tax reporting that is not only different from regular employee tax reporting but different even from reporting for traditional independent contractors.
Employees, as the TIGTA report notes, are subject to wage withholding and withholding on Social Security and Medicare taxes on a pay-as-you-earn (PAYE) system. Wages paid and taxes withheld are reported annually to the IRS and the employee on Form W-2.
Traditional independent contractors who provide services to a payor, while not subject to PAYE withholding, are issued a Form 1099-MISC by the payor each year. The Form 1099-MISC, subject to a $600 threshold, reports to the IRS and the contractor payments made to the contractor for the tax year. The independent contractor would be expected to include such payments in gross income and calculate and pay self-employment taxes and estimated taxes on such income.
Gig workers, however, tend to receive a Form 1099-K. But like other independent contracts, they are not subject to PAYE withholding and must pay their own self-employment taxes and estimated taxes. Uber drivers, for example, receive a Form 1099-K that reports earnings from fares for rides given (though they may also receive a Form 1099-MISC for certain incentives paid directly by the company). Form 1099-K, formally titled “Payment Card and Third Party Network Transactions,” is used by payment settlement entities (PSEs) to report payments to vendors and other parties. PSEs include credit card companies (merchant banks) that are required to use Form 1099-K to report card payments made to merchants settled through the merchant bank’s payment network. PSEs also include entities known as third party settlement organizations (TPSOs).
TPSOs are third parties that have agreed to handle payments between persons providing goods or services and the purchaser of those goods or services. The TPSO guarantees to the provider payment for the goods or services purchased on the network. Form 1099-K reporting stems from Internal Revenue Code section 6050W which was enacted in 2008. At the time of enactment, a TPSO was thought of as an entity like PayPal, an organization that processed payments for something like an online auction site, receiving payments from purchasers and making payments to sellers in settlement of the online sales.
Since then, a number of the online platforms fostering the sharing or gig economy have patterned themselves as TPSOs. The significance of this from a tax reporting and compliance perspective is that TPSOs only need to report on Form 1099-K if a de minimis threshold is exceeded. Reporting is required only if a payee receives more than $20,000 in reportable payments and had more than 200 transactions.
Based on TIGTA’s analysis, this creates a significant gap in tax reporting, the more pronounced with each growth spurt of the gig economy. The TIGTA report provides this visual chart:
Essentially, TIGTA looked at 3 online platforms that elected to report on Form 1099-K irrespective of dollar thresholds and plotted, for comparison, the number of returns and payment amounts that would have been reported to the IRS at a $20,000 threshold vs a $600 threshold (the de minimis threshold for reporting income to a contractor on a Form 1099-MISC). If all payments were reported, the sample results in 2.4 million Forms 1099-K to the IRS, representing $10.7 billion in payments. At the $20,000 threshold, only 130,682 returns would have been filed with the IRS, representing only $4.9 billion of payments. A little math reveals a gap of close to $5.8 billion in payments that would have been unreported.
However, TIGTA’s analysis also showed that if the threshold were $600, the IRS would have received 1.4 million returns, representing $10.5 billion in payments (close to the total).
The TIGTA report, among numerous other items, recommended that guidance be provided to clarify certain section 6050W-relevant definitions for potential reporting entities, including when an entity actually qualified as a TPSO (eligible for the de minimis threshold) versus what is known as an aggregated payee which would not be so eligible. IRPAC (an independent IRS advisory committee on information reporting) had also in the past asked for additional guidance relating to section 6050W terms. Remember Uber launched in 2009 and was not even in existence when section 6050W was enacted.
The report also advised that the Treasury advocate for legislative changes to the section 6050W reporting rules, seemingly suggesting in effect that the generous $20,000/200 transaction reporting threshold that might have been reasonable at the time when there was only the odd online auction payment processor might not be sensible in a world with a burgeoning population of gig workers. TIGMA cited figures that 8% of the American population did some gig work in 2016; plus some 18% had sold items online. So developments are worth monitoring.
Interestingly, states have already become aware of this regulatory gap. Both Massachusetts and Vermont enacted legislation that required that state-equivalent Form 1099-K reporting by TPSOs be based on a new $600 threshold, effective for tax year 2017.
Developments with Form 1099-K reporting have also taken an interesting turn even for information reporting specialists not dealing with reporting for merchant banks and third party payment processors. Form 1099-K reporting has recently popped up in the world of financial account reporting as certain cryptocurrency exchanges have begun to issue Form 1099-K to their customers, though guidance for tax reporting in the cryptocurrency area is probably less clear than with respect to the gig or sharing economy platforms.
Both in the case of the sharing economy and changes brought about by cryptocurrencies and blockchain, technology has outstripped the regulatory framework that had been developed for more traditional businesses and assets. The TIGTA report in the end provides us a peek at a sort of black hole that is created when this happens and the impact: confused filers and taxpayers, low compliance rates and a widening tax gap for the fisc.