What’s Up with Tax Law for Gig Workers?

If someone whispered in your ear, “Are you a gig worker, and how are you taxed?,” would you panic and say, “I don’t know”? A gig worker is an individual who works in a sector that is considered independent and on demand. Think of areas such as Etsy, eBay, Uber, Lyft, etc. Those are the individuals who heard about California Assembly Bill 5 (AB5) and thought it was time to leave this rodeo we call the state of California. It gets confusing and overwhelming being in these sectors because you are a business owner who needs to know the ins and outs of federal and state taxation, all while juggling a small business, making products, dealing with unhappy customers, etc.

The topic of gig workers has been a frequent point of conversation of late, especially with respect to the new tax laws surrounding their way of making a living. The COVID pandemic really brought these types of individuals and small businesses into the national and state spotlight as more things became Internet friendly and on demand while we all sat at home wondering how the modern world had crumbled so quickly. We probably are all sitting here reading this and thinking, I have definitely funded many gig workers on Etsy during the holidays, as well as through those late-night Grub Hub runs for ramen.

California tries to categorize many gig workers who are not operating through an incorporated business as employees of those whom they are serving. California uses the prongs of AB5 to solidify this determination and audit review. The gig worker industry, supported by Uber and Lyft, sought a carve-out from AB5 through California ballot Proposition 22. Proposition 22 stated that those individuals operating as drivers on rideshare-type apps such as Uber and Lyft are exempt from being classified as employees of those companies and therefore are not entitled to benefits such as sick leave, unemployment insurance, etc. After voters approved Proposition 22 on November 3, 2020, the state of California took to the court system to block its enforcement. Initially, the courts ruled that Proposition 22 was unenforceable, but on March 13, 2023, California’s First District Court of Appeals overturned the lower court’s ruling and declared the amendment to be constitutional. Drivers for Uber and Lyft were to be categorized as independent contractors. The battle will most likely be taken to the California Supreme Court. California AB5 and the current fight over gig workers is a battle that will eventually be fought and determined on a national level. At the moment, each state determines the classification, but the federal government will soon start to pay more attention, especially as they tighten down on income-reporting requirements for these industries.

The U.S. Internal Revenue Service (IRS) recently made changes to tax regulations that impact gig workers’ income and how they need to account for it. And while states have their own regulations regarding gig workers—California being among the states with the strictest rules—it’s important to understand the new IRS regulations if this is the profession that you continue to work in. Gig workers typically earn money from providing on-demand work, goods, or services, and those services are often conducted through a website or app. While gig work is often considered supplementary to full-time income, the money earned is taxable and must be reported to the IRS.

When the American Rescue Plan Act of 2021 was passed, it included a provision that primarily affected gig workers and independent contractors with a side hustle. Before the act, companies such as Venmo, PayPal, Cash App, Square, Stripe, StubHub, Etsy, and eBay were only required to send an IRS Form 1099-K to individuals with gross payments exceeding $20,000 and more than 200 transactions within a calendar year. Many individuals who operated as gig workers easily flew under the radar of this level for a long time with no limelight pointed their way.

However, the new provision requires third-party payment processors to report payments received for goods and services of more than $600 a year. This is a huge difference! It means if someone sells goods or conducts a service and collects payments of more than $600 through one of those companies, he or she will receive a 1099-K, and that income will be reported to the IRS. Now, don’t panic about the $650 you just paid back to your friend for the plane tickets she bought to Mexico to get out of this rainy and cold weather—that’s not taxable. The 1099-K issuing platform, for the most part, will be able to determine what is income and what is not based on the type of account, types of transactions, number of transactions, etc.

When an individual works full-time for an employer, that employer is responsible for withholding income tax from the employee. Gig workers are responsible for paying their own income taxes. They can do this by making quarterly estimated tax payments throughout the year, which includes self-employment tax. Additionally, if gig workers are self-employed, they must pay all their Social Security and Medicare taxes on their income from the gig activity. This information is reported to the IRS directly via the company issuing the 1099-K, and the IRS’s computer system will be looking for this income on your individual or business tax return.

It’s very important that a gig worker is correctly classified by the employer or online company that is brokering the transaction (e.g., eBay, Uber, Lyft, etc.). This is also true for independent contractors and those providing freelance services. The businesses they serve must either classify them as employees or independent contractors. This determines who is responsible for taxes to the IRS. Generally, taxpayers can use the IRS’s worker classification page to see how they should be classified. However, some states—California being a big one—has much stricter classification standards. Be sure to check your state’s regulations and not just rely on the federal classification.

The new gig worker provision in the American Rescue Plan Act of 2021 was set to take effect January 1, 2023. However, the IRS pushed that implementation date back to January 1, 2024, which means the new reporting requirements will take effect for the 2023 tax year. That being the case, it does not mean gig workers should not be tracking and reporting their income from these sites just to confirm that all income is correctly accounted for. The IRS does require reporting of any income whenever a gig worker or independent contractor receives a Form 1099-K from the company.

If you are a gig worker or a company that pays independent contractors, it’s important to understand these new requirements and put practices into place now, at the start of the 2023 tax year. Don’t feel overwhelmed—all the tools needed are available on the federal and state websites. And if you still feel overwhelmed, just order some Grub Hub, say hello to your fellow gig worker as you drown your sorrows in takeout, and reach out to a tax professional to help!