Today is Tax Day — the deadline for Americans to file their 2017 tax returns. The annual Spring ritual of last minute filings and extension applications makes Tax Day one of the most difficult days of the year for millions of Americans. A Gallup 2011 poll found that it is the second most stressful day of the year, while University of Toronto researchers found that the risk of fatal road crashes goes up on Tax Day.
Tax Day is particularly difficult for independent workers, including freelancers and independent contractors, who often lack common conveniences that are provided by many employers to traditional employees such as income and FICA tax withholding, workplace retirement plans with automatic withholding, employer-provided health insurance paid with pre-tax dollars, and more. Independent workers are also required to pay estimated taxes on their net earnings quarterly — a complicated process, especially for those with uneven earnings throughout the year.
In addition to being cumbersome, the tax filing process also results in improper payments. Only one percent of traditional wages go unreported; employers are required to withhold taxes and report that income to the IRS . In contrast, a whopping 63 percent of income is unreported when it is subject to neither withholding nor reporting — as is the case for self-employment income. The impact of these errors is huge: individual taxpayers underreported $190 billion of business and self-employment taxes from 2008 to 2010, nearly 60 percent of the total underreporting by individual filers. Some independent workers may be paying too much in taxes, too. According to a survey by the Kogod Tax Policy Center, nearly half of independent workers are unaware of small business deductions, credits, and even basic expensing, all of which could lower their tax bill.
The recent tax reform bill — the Tax Cuts and Jobs Act (TCJA), passed by Congress last December — will do little to solve these problems for independent workers. That bill made many significant changes to the code, including reducing income tax rates for individuals and corporations; increasing the standard deduction; doubling the child tax credit; capping state and local tax exemptions; and repealing the individual mandate from the Affordable Care Act. In addition, it allows many independent and self-employed workers to receive a new tax deduction of up to 20 percent of net income, potentially reducing their tax burden depending on their income level. But the new law failed to improve the complicated and cumbersome process of tax filing — in fact, the new 20 percent deduction arrives with new rules and appears to add complexity to a system that is already difficult to navigate.
Most traditional workers will not have to file their taxes under the new tax law until 2019, when they file for 2018 earnings. However, today marks the first day that independent workers need to file 2018 quarterly taxes, meaning that they are the first taxpayers to file under the new law. They are the proverbial canaries in the coal mine.
A number of proposals have been introduced to help address the tax-filing challenges independent workers face. Sen. John Thune has proposed legislation that would create an incentive for businesses to withhold taxes on behalf of some independent workers as part of an alternative classification arrangement. Congressman Chabot and Congresswoman Velazquez have introduced a bill that would allow businesses to offer tax withholding to independent workers without that action being used against them in a misclassification lawsuit. And the e-commerce platform Etsy recommended including withholding for independent contractors in their proposed universal portable benefits system.
A first step that policymakers can take it is to learn more about the challenges facing independent workers on Tax Day. As we proposed in our Toward a New Capitalism policy agenda, Congress should (1) 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 workers; and (2) direct the IRS to survey on-demand workers to determine their tax compliance and adoption of the small business tax provisions available to them.
As lawmakers assess the impact of the new law and ways to improve it, we are hopeful that they will examine ideas that make the tax-filing and compliance system for independent workers less onerous, as this segment of our workforce continues to grow. Tax Day is particularly challenging for independent workers — let’s make it easier for them.