Financial reporting for gig workers (temporary, flexible workers such as independent contractors and freelancers instead of full-time employees) has always been complicated and recent legislation under The American Rescue Plan Act of 2021 (ARPA) will continue this complexity and have a significant impact on gig economy workers and the companies and platforms who host them. Due to the March 11, 2021 ARPA legislation, the IRS will significantly expand their 1099-K reporting requirements. As part of the legislation, Internal Revenue Code 6050W was amended so that impacted reporting agencies and workers with minimal activity will now be subject to increased reporting requirements starting in the 2022 tax year.
Historically, organizations that facilitated payments between parties were known as Payment Settlement Entities (PSE). PSEs included both Merchant Acquiring Entity (MAE) and Third-Party Settlement Organizations (TPSO) that were subject to 1099-K reporting. Whereas the de minimis threshold for Third-Party Settlement Organizations (TPSOs) previously required reporting for transactions in excess of $20,000 and 200 transactions, the de minimis threshold for Form 1099-K now applies to $600 of transactions for any payee regardless of the number of transactions.
Over the last decade, the need for gig workers has expanded across industries and this growth has intensified during the COVID-19 pandemic as more consumers look to gig workers to meet their essential needs. For example, Instacart added over 300,000 shoppers due to the spike in grocery delivery demand brought about by the pandemic. Many gig platforms such as Uber and DoorDash generally do not function as an employer and are not the direct recipient of vendor services or goods and thus not subject to the 1099-MISC reporting rules. Rather, these gig platform companies function as a third-party intermediary facilitating transactions between the customer and worker.
Consequently, the current Form 1099-MISC and Form 1099-K thresholds allow a significant number of gig workers to avoid having their income reported to the IRS. The IRS’s Tax Gap study estimates that when there is no information reporting, the compliance rate is only 37% by taxpayers. This likely means that a significant number of gig workers are underreporting their income resulting in billions of dollars in lost tax revenue. The US Treasury has been monitoring this trend and argued in a recent report that the expansion of the gig economy indicates that the IRS should focus on improving self-employment tax compliance.
The recent amendment is expected to increase both income tax and self-employment tax reporting by gig workers. As a result of this change, it is expected that many gig workers will receive Form 1099-K in 2022 as compared with prior years. Consistent with prior years, the reporting requirements for Form 1099-K still only apply to payments made for goods or services. Other types of payments such as rent and royalties are subject to other 1099 requirements.
What Does This Mean?
As taxpayers prepare for the 2022 tax season, businesses and platform companies should review their status as a third-party settlement organization to determine if they are ready to comply with the increased reporting requirements. In many cases, companies may need to review their process of collecting tax identification numbers and for reporting transactions. Since the financial penalties for missed or incorrect 1099 filings rest with TPSOs and MAEs, advanced preparation will help mitigate these penalties.
Companies should consider automating their tax reporting process to include compliance monitoring and internal reporting. Additionally, companies should review their process for back-up withholding. Since some states have more stringent rules for Forms 1099-K than currently exist for federal purposes, it is important for companies to review state requirements in addition to the new federal requirements.
Gig workers and independent contractors should continue to make estimated payments and work with their financial and tax advisors to make sure that all taxable income is reported. It’s important for these taxpayers to remember that while the Form 1099-K reports income, it does not include expenses such as cost of goods sold or other operating expenses which could impact whether gig workers are operating at a taxable profit or loss.
For a comprehensive list of requirements, see IRS instructions here or contact your tax advisor.