The gig economy is a sector of the workforce in which people do not have long-term employment. Those in the gig economy are contingent workers—freelancers, consultants, tradespeople—who cannot necessarily count on their next gig. They may obtain assignments or projects through companies such as Uber, Lyft, TaskRabbit, or Upwork, or they may engage directly with companies or individuals needing their talents. The Bureau of Labor Statistics recently pegged the size of the gig economy as of May 2017 at 3.8%, or approximately 5.9 million people (“Contingent and Alternative Employment Arrangements News Release,” June 7, 2018, http://bit.ly/2O8bsYR).
These individuals face important financial and tax challenges. This article focuses on gig economy workers who are independent contractors (note that not all gig workers are self-employed) and addresses the issues that are key to them. Of course, some employees may moonlight in the gig economy, but they do not have the same concerns as those who work exclusively in this sector. In addition, some people may share their homes through Airbnb or other sites; they do not face the same tax and financial issues as gig workers and are not discussed here.
Savings and Budgeting
Because income from freelancing, consulting, or other contingent work is not necessarily steady, it is vital for a gig worker to be proactive in managing money. This includes establishing a savings program to create a financial cushion when things are slow. It also requires careful budgeting so that funds are not frivolously spent when they come in, but are instead applied for various necessary purposes (e.g., estimated taxes, retirement savings, a rainy day fund).
The concepts of savings and budgeting may be foreign to many individuals. As employees, they may have lived paycheck-to-paycheck knowing that their taxes were covered through withholding and their personal concerns (e.g., healthcare, retirement savings) were handled by their employers. In the gig economy, they must take personal responsibility for these matters.
One of the prime concerns of most workers today is health coverage. Many employers offer this benefit, but those who work exclusively in the gig economy must find coverage themselves. This can be done in several ways:
Buying individual (or family) coverage.
For workers with income below a certain level, it may be preferable to go through a government marketplace (https://www.healthcare.gov/). If such a person qualifies for the premium tax credit, it can be used to pay some or all of the premiums on an advanced basis. For workers with higher income, the best way to find coverage is through trade groups or business associations.
To keep premium costs down, the worker should consider a high-deductible health plan combined with a health savings account (HSA). The cost of the premiums for this type of coverage is significantly lower than traditional coverage, and contributions to the HSA offer triple tax benefits: contributions are tax deductible (no itemizing is required), there is no current tax on earnings in the account, and withdrawals to pay qualified medical expenses are tax free. Funds tapped for nonmedical purposes are subject to a 20% penalty unless the individual is age 65 or older.
Being covered through a spouse’s health plan.
If the gig worker is married and the spouse has such an option, this can be an affordable and welcome option.
If a worker has left a job that offers COBRA, he can continue coverage for up to 18 months by paying the premium (plus a 2% administrative charge). The cost of this coverage may be more or less than buying individual coverage, so shopping around for alternatives is advisable.
For self-employed individuals, health insurance premiums are fully deductible from gross income. Itemization of deductions is not required.
For a self-employed individual, becoming injured and unable to work can present a significant financial problem. Regular employees who are injured on the job have workers’ compensation protection; they may also enjoy long-term disability coverage through their employer. Gig workers must take care of themselves in this regard by considering privately obtained disability insurance, which replaces a portion of lost income due to long-term disability.
A worker may qualify for Social Security disability payments, but this will probably be insufficient. The amount of the payments may not adequately replace lost income, and eligibility for the payments is not always easy to prove. A person can qualify only if it can be shown that she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than 12 months.
Employees may be able to participate in company-sponsored retirement plans, but gig workers must save for their own retirement. They must determine which type of retirement plan is best for them and be sure to fund it annually. Options include the following:
- 401(k) plans. Solo plans enable the self-employed to make both employee and employer contributions. In 2018, this means a total maximum contribution of up to $55,000 ($61,000 for those age 50 or older). If the individual makes elective deferrals to an employer’s 401(k) and also sets up a solo 401(k) for the gig work, the overall annual limit on elective deferrals applies. Thus, for 2018, the person cannot make total elective deferrals of more than $18,500 ($24,500 if age 50 or older) to both plans.
- Simplified employee pensions (SEP). These plans are easy to set up and allow for annual contributions up to 20% of net earnings (after subtracting self-employment tax), but no more than $55,000. Those who are able to save 20% of their earnings each year will amass a sizeable retirement fund. For example, if a person is eligible to and does contribute $10,000 annually (in equal monthly amounts) and earns 5% annually, there will be nearly $375,000 in the plan after 20 years.
- Individual retirement accounts (IRA). If the worker does not have a 401(k) or SEP and is under age 70½, he can contribute to an IRA and deduct the contribution (no itemizing required). For 2018, the cap on contributions is $5,500 ($6,500 if age 50 or older). If the worker has a nonworking spouse, additional contributions can be made up to the same cap.
- Roth IRAs. Regardless of age and whether or not the person has a 401(k) or SEP, workers can contribute annually to a Roth IRA as long as modified adjusted gross income does not exceed a set amount. The dollar limits on contributions to an IRA also apply to a Roth IRA, and the one annual limit applies if contributions are split between a regular and Roth IRA.
Finding the money to put into a retirement plan can be difficult for some. The point to remember is that contributions (other than for Roth IRAs) are tax deductible; thus, in effect, the government is contributing a portion of the funding. For a gig worker in the 22% tax bracket, the tax savings from a $10,000 contribution to a SEP is $2,200 (i.e., the government’s contribution).
___ Do I have health insurance?
___ Have I considered a health savings account?
___ Do I have disability insurance?
___ Have I selected a retirement plan to fund?
___ Do I understand my tax obligations?
___ Have I considered registering with EFTPS.gov to pay my estimated taxes?
___ Should I have a separate bank account to save for estimated taxes?
___ Have I explored special tax breaks to which I may be entitled?
Gig workers must report their income and pay taxes on it; this includes both income tax and self-employment tax to cover Social Security and Medicare taxes. Unfortunately, many gig workers who previously were used to being W-2 employees with wage withholding are unfamiliar with their tax responsibilities.
All income earned must be reported on Schedule C (or C-EZ). Gig workers may receive information returns (Form 1099-MISC or Form 1099-K) listing certain earnings; whether or not an information return is received, the income should be reported. For example, a person may receive $500 for a project that is not reported on Form 1099-MISC because it is below the $600 threshold at which the form is required, but the payment is still reportable income. Income reported on Schedule 1099-K need not be reconciled with income reported on the return (there can easily be differences because of returns and allowances), but the IRS has used them to flag unreported income.
Paying self-employment tax.
Gig workers are also subject to self-employment tax, which comprises Social Security and Medicare taxes. As self-employed individuals, they pay both the employer and employee share of these taxes, with one-half deductible as an adjustment to gross income.
Gig workers must be prepared to show that they’re engaging in an activity with a reasonable intention of making a profit, and not for personal pleasure or recreation
Paying the additional Medicare tax.
Income from gigs is potentially subject to the 0.9% Medicare tax. It is not part of the self-employment tax, and it is not deductible. It should be factored into estimated taxes (discussed below).
Making estimated tax payments.
Because there is no withholding, gig workers usually have to satisfy their tax obligations through the payment of estimated taxes, which may be unfamiliar to many gig workers. Estimated payments are made to cover federal tax obligations four times per year. This chore can be simplified by using the Electronic Federal Tax Payment System website (https://www.eftps.gov/eftps/) to schedule payments. This free service directs the U.S. Treasury to withdraw a specified amount of money from a designated bank account on a specified date; it does not give the government access to the bank account for any other purpose.
Even more challenging than remembering to make estimated tax payments is having the cash on hand to pay them. Rather than spending all the money that comes in, it is highly advisable for a gig worker to set aside a set percentage of earnings (e.g., 10%, 20%) to create a fund for estimated tax payments. This can be done, for example, through a separate bank account.
Another strategy, if the worker has a spouse who is employed, is for the spouse to adjust to cover the estimated taxes of the gig worker (assuming the spouse is agreeable to this).
Special tax breaks.
The gig worker may be entitled to special tax breaks:
- Home office deduction. If the home is the principal place of business, or there is no other fixed location for the person and space in the home is used to do administrative work (e.g., keep books and records, do research, schedule appointments), then the worker may be eligible for a home office deduction. The space must, however, be used regularly and exclusively for this purpose. Some individuals are reluctant to take a home office deduction for fear that it is an audit red flag, but there are no statistics supporting this belief, and the IRS encourages eligible taxpayers to take the write-off.
- Qualified business income deduction. Starting in 2018, there is a potential 20% deduction from taxable income based on business income. While several limitations apply, anyone with taxable income below $207,500 ($415,000 on a joint return) likely can benefit from this new deduction.
One of the potential problems facing some gig workers is the hobby loss rule (Internal Revenue Code section 183). This is triggered when expenses from an activity exceed the income from the activity, and the rule requires all income to be reported but only allows a deduction for expenses to the extent of income. The deduction for these expenses is a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income floor, which means that for 2018 through 2025, because of the suspension of this deduction, there is no write-off for any expenses related to a hobby activity. Thus, gig workers must be prepared to show that they’re engaging in an activity with a reasonable intention of making a profit, and not for personal pleasure or recreation (Treasury Regulations section 1.183-2).
Tax law requires all businesses to keep books and records, which may be another task unfamiliar to a gig worker. Nonetheless, this must be done to keep track of income and expenses. Fortunately, there are many accounting solutions that do not require a knowledge of accounting or being good at numbers. The IRS has a Sharing Economy Tax Center (http://bit.ly/2uPlXs3) that provides an overview of tax responsibilities and links to various IRS resources for gig workers.
Rising to the Task
Providing guidance to individuals who are working in the gig economy is an important service. CPAs and other financial advisors should be sure to take a holistic approach to help these individuals address all of their financial and tax concerns.