Workforce Development

Congressional Proposal Updates Tax Code to Reflect Changing Nature of Work

September 18, 2017  • Alastair Fitzpayne & Ethan Pollack

With a temporary fix to the debt ceiling and a short-term government funding solution in place, the debate around comprehensive tax reform is heating up. Much of the debate will focus on what individual and corporate tax rates should be to improve economic growth and job creation, and the impact that lower rates could have on increasing income inequality. But policymakers should also take the opportunity to make the tax code more user-friendly, especially for independent workers who, unlike those in traditional jobs, face a maze of complex tax filing requirements. For this reason, we are encouraged by provisions in the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2017 introduced over the summer by Sen. John Thune (R-SD) that takes some steps to help independent workers comply with the tax code.

The tax code was last reformed in 1986. Over the last 31 years the economy has changed in profound ways that have fundamentally altered how people work. Growing numbers of workers are now engaged in independent work – short-term, part-time, and project-based work where individuals provide services independent of a formal employer-employee relationship. These workers are freelancers, independent contractors, temporary, or on-call workers. With the advent of smartphones and online platforms – such as Uber, Lyft, Postmates, and others, this trend has grown dramatically.

Traditional employees typically rely on their employer to help them properly comply with their tax obligations. These services include withholding a specific portion of their paycheck each pay period, making quarterly estimated tax payments, providing them a W-2 at the end of the calendar year, and reporting this information to the IRS. In addition, tax obligations for Social Security, Medicare, and unemployment insurance are similarly deducted from employees’ paychecks and sent to the relevant government agency. In contrast, independent workers are expected to manage these tax obligations on their own, including figuring out on a quarter-by-quarter basis how much of their earnings should be sent to the IRS as an estimated tax payment and then reporting their total income (which may come from many different sources) at the end of the year.

Thirty years ago, many independent contractors were sole proprietors that functioned as full-time small businesses, and were thus better-equipped to handle these complex and laborious tasks. But the profile of a typical independent worker today is very different. Independent workers are younger, less financially sophisticated, work fewer hours, are more likely to hold multiple jobs, and make less money than the average worker. Tax law professor Kathleen Delaney Thomas notes that applying tax rules that were designed for traditional sole proprietors to gig workers is not only burdensome and inefficient, but likely leads to lower tax compliance given the difficulty of accurately paying taxes in this manner.

Tax compliance is also made more difficult by the rules that specify when digital platforms must report their workers’ income to the IRS. Under current law, online labor platforms do not need to report payments to their workers unless those payments exceed $20,000. This threshold excludes most independent workers. According to a survey by American University’s Kogod Tax Policy Center, more than 60 percent of those employed by online platforms did not receive 1099 tax forms from their platform, making it difficult for the IRS to understand if gig economy workers are meeting their tax obligations.

This summer, Sen. Thune introduced legislation that attempts to modernize the tax treatment of gig economy workers. The bill requires companies that use alternative criteria to classify workers withhold 5 percent of their payments to these independent workers. While the classification criteria will be hotly debated, requiring these companies to help workers with tax withholding would simplify tax filing for these workers.

Sen. Thune’s bill would also simplify the process of information reporting for independent workers. Under current law, labor intermediaries – such as online labor platforms that connect service providers with customers – only report to the IRS their payments to independent contractors if they exceed $20,000 and there are over 200 separate transactions. By contrast, businesses that contract directly with a service provider must report payments that exceed $600. Sen. Thune’s bill would harmonize the reporting threshold for all businesses and set the threshold at $1,000. This change would cause labor platforms to report far more of their payments to workers and to the IRS.

The NEW GIG Act echoes two proposals presented in Toward a New Capitalism, the Future of Work Initiative’s policy agenda to help workers and businesses succeed in the new economy. First, we proposed that Congress direct the Treasury Department’s Office of Tax Policy to undertake a comprehensive study of the current tax withholding and reporting system to identify how it should be updated to reflect the growing number of independent contractors. And second, we proposed that Congress direct the IRS to survey on-demand workers to determine their tax compliance and whether they take advantage of the small business tax provisions available to them to reduce their tax burden. This latter proposal reflects the findings of the Kogod survey that nearly half of independent workers  are unaware of small business deductions, credits, and even basic expensing, likely causing some to actually pay too much in taxes.

Changes in the economy and workforce require lawmakers to update the tax code for the new forms of work. Sen. Thune’s bill deserves credit for continuing the conversation around ways that gig economy work can be performed without onerous tax filing burdens. We are encouraged to see policymakers focus on modernizing the tax code to reflect the realities of independent workers, and we hope that the NEW GIG Act will spark a broader discussion in the context of tax reform about other ways to improve the tax code for these workers.