As the gig economy continues to grow, so does the IRS’s interest in ensuring that freelancers and independent contractors are meeting their tax obligations. From ride-share drivers to freelance designers, the gig economy now encompasses millions of workers, many of whom may not fully understand their tax responsibilities. Recent changes in IRS policy have amplified their scrutiny of gig economy workers, with an increased focus on tax compliance. Here’s what you need to know to stay on the right side of the law.
Why Is the IRS Cracking Down?
One of the most significant challenges of remote work is multi-state taxation. Before the remote work trend, most employees worked in the same state where their employer was located. Now, employees may live and work in one state while their employer is based in another. This can trigger tax obligations in multiple states, both for employees and the businesses they work for.
The rise of gig work has presented challenges for tax enforcement, especially as many workers may not receive the traditional W-2 forms that full-time employees rely on. Instead, most gig workers receive a 1099-K or 1099-NEC, forms that report income earned from third-party platforms or direct payments for services rendered.
In recent years, the IRS has made it clear that they are focusing on this sector to ensure all income is reported. The reason? A significant portion of gig income may go unreported, leading to a substantial loss of tax revenue. Underreporting income or misclassifying work expenses could lead to hefty penalties, audits, or both.
What the IRS Is Looking For
Underreported Income: Many gig workers don’t realize that all income, no matter how small or intermittent, must be reported. The IRS has new tools and technologies to detect discrepancies between reported income and actual earnings through platforms like Uber, Etsy, or Upwork.
Misuse of Deductions: Gig workers are allowed to deduct legitimate business expenses from their taxable income, but the IRS scrutinizes deductions to ensure they are valid. Improper deductions or personal expenses claimed as business expenses can lead to red flags.
Misclassification of Employees: Many companies in the gig economy classify workers as independent contractors to avoid paying employment taxes. The IRS is cracking down on businesses that improperly classify workers who should be treated as employees. Gig workers must understand their classification, as it affects tax reporting and eligibility for certain deductions.
Staying Compliant: Key Steps for Freelancers and Independent Contractors
1. Track All Income
Whether you’re earning through one platform or multiple, you must report all income to the IRS. Even if the platform or client doesn’t provide you with a 1099 form (which is required for earnings over $600), the income must still be reported. Many freelancers overlook income earned from smaller jobs, which can lead to problems later.
Pro Tip: Keep detailed records of all income sources throughout the year. Consider using accounting software or an app to track payments in real-time. This way, you’re not scrambling to gather information at tax time.
2. Know Your Deductions
Freelancers can deduct several business-related expenses, which can significantly lower taxable income. Common deductions include:
Home Office Deduction: If you use part of your home exclusively for business, you may qualify for a home office deduction.
Supplies and Equipment: Laptops, software, and any tools essential to your trade are deductible.
Vehicle and Travel Expenses: If you use your car for business purposes, you can deduct mileage or actual vehicle expenses.
Marketing and Advertising: Business cards, websites, or paid ads are legitimate business expenses.
Note: The key to deductions is ensuring they are directly related to your business and properly documented. Save all receipts and records, as the IRS requires proof for every deduction claimed.
3. Set Aside Taxes Regularly
Unlike W-2 employees who have taxes withheld from their paychecks, gig workers must handle their own tax withholding. It’s crucial to estimate your tax liability and set aside money throughout the year to avoid a hefty bill when filing. Depending on your earnings, you may also need to make quarterly estimated tax payments to the IRS.
Pro Tip: A good rule of thumb is to set aside 25-30% of your income for taxes, including both income tax and self-employment tax (which covers Social Security and Medicare).
4. Stay Up to Date on Tax Law Changes
Tax laws for gig workers are constantly evolving. For example, the IRS recently lowered the threshold for 1099-K reporting from $20,000 in payments or 200 transactions to just $600 in total payments starting from 2023. This change means more gig workers will receive 1099-K forms, even for small amounts, and it’s essential to report this income properly.
Pro Tip: Work with a tax professional who understands the gig economy to ensure you’re aware of any changes that could impact your tax filings.
The Consequences of Non-Compliance
Failing to comply with IRS regulations can have serious consequences. Common issues include:
Audits: If your tax return raises red flags, such as underreported income or questionable deductions, the IRS may audit you.
Penalties: Late payments or underpayment of taxes can result in substantial penalties, which may include interest on the outstanding amount.
Legal Action: In severe cases, tax evasion or willful non-compliance could result in legal action, including fines and criminal charges.
Seek Professional Guidance
With the IRS intensifying its focus on gig economy workers, staying compliant with tax laws has never been more important. Working with a Certified Public Accountant (CPA) can help ensure you’re filing correctly, claiming the right deductions, and setting aside the appropriate amount for taxes. Navigating the tax complexities of freelance work is challenging, but with the right guidance, you can avoid costly mistakes.
If you’re unsure about your tax obligations or need assistance preparing your tax return, it’s always best to consult a professional. I have extensive experience helping gig workers, freelancers, and independent contractors stay compliant with IRS regulations. Whether you need help tracking deductions, filing quarterly taxes, or managing your tax strategy, I can provide personalized guidance to keep you on track. Contact our office today to schedule a consultation and ensure you’re prepared for tax season.
About the Author
Cherie Sayban is a certified public accountant. She has over 25+ years of experience in Finance, Accounting and Bookkeeping.
Cherie Sayban CPA provides various financial and accounting solutions to small and mid-size businesses. Our portfolio includes: tax preparation, payroll preparation, accounts receivable and payables, general ledger, and QuickBooks . Our bookkeeping workshops are offered both in-person and virtually.
To learn more about how Cherie Sayban CPA can help you and your business, click HERE
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