The burgeoning gig (aka “sharing”) economy is creating opportunities for your clients of all income levels to earn extra cash. But it also creates obligations to pay taxes—something many Americans either don't realize or don't care to comply with.
“I’ve encountered many [clients] who think their side job is de minimis and they don’t need to declare the income,” says Gail Rosen of Wilkin & Guttenplan in Martinsville, N.J. “I tell them that not reporting income is considered tax fraud, which can lead to audits, penalties and, depending on the extent, prison.”
If your client receives income from a sharing economy activity, it’s generally taxable even if your client doesn’t receive an IRS Form 1099-MISC (triggered if your client earns at least $600 from an employer), 1099-K, W-2 or other income statement. This taxability applies if your client holds a side job, runs a part-time business or is paid in cash.
According to a recent survey from Finder.com, almost 70 million workers fail to declare an estimated total of $214.6 billion to the IRS annually.
These were some of the survey's other findings:
• More than a third of those with annual incomes of $150,000 to $300,000 don’t claim money made on the side, more than any other income bracket.
• Side hustlers made $3,075 on average off the books over the last year.
• A third of millennials said they don’t declare money made on the side, followed by Gen Xers (26 percent) and baby boomers (16.6 percent).
• Of those who make extra, men (30.7 percent) are more likely than women (27.4 percent) not to declare it to the IRS.
“Many times I’ve had to explain to clients that income earned from all sources needs to be declared,” says Jeffrey Gentner, enrolled agent and tax preparer in Amherst, N.Y. “Clients aren’t always happy about this but usually understand [their] liability and responsibility.”
If you suspect your client may be a non-filing part-timer, you can at least offer them a nugget of business tax breaks: losses. Business expenses are limited on the amount that can be deducted and claimed on Schedule A as a miscellaneous deduction subject to 2 percent of a client’s AGI. “By contrast,” Rosen says, “if their business is not affected by the hobby-loss rules, all otherwise allowable expenses would be deductible on Schedule C, even if they exceed income from the enterprise.”
Generally, the IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year. If an activity is not for profit, losses from that activity may not be used to offset other income.
Says Gentner, “I spend a lot of time discussing the hobby rules [and] those of small business and the importance of good records and documentation. Sometimes a good discussion of ‘employee’ versus ‘contractor’ is in order.”
The general rule, says the IRS, is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Worker classification determines if an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Businesses normally do not have to withhold or pay any taxes on payments to independent contractors; an independent contractor’s earnings are subject to self-employment tax.