Gig Worker Compliance Challenges Including AB 5

On 10/1/19, the Franchise Tax Board (FTB) held a meeting, chaired by State Controller Betty Yee, focused on compliance for gig workers. You can see by the agenda that many topics were covered including background data on understanding the gig economy which for the meeting meant those finding income opportunities from web platforms such as Uber, Postmates, TaskRabbit or hundreds of other similar sites.

I was honored to participate on a panel on Challenges and Opportunities for Tax Compliance in a Gig Economy. A few points I offered:

• The issue of worker classification is decades old and a big issue that Congress left unaddressed since at least 1978 with "Section 530" of the Revenue Act of 1978. This provision results in some workers being contractors for purposes of the employer's employment taxes, but employees for other purposes including for the worker's tax obligations. It is unfortunate that the multitude of classification schemes among federal and state laws has been allowed to continue for so long. I was hoping that the emergence of the platform work arrangement might finally be a time to look at this broken system, but apparently not yet. Instead we are getting more variations (such as California's AB 5 making many workers employees where other states enacted laws in 2018 clarifying that the platform workers were contractors).  The hearing didn't delve into the possibility of the need for a third category of work arrangement as this was focused on compliance rather than policy changes via legislation.
• We need to provide wider tax education to everyone, such as by including tax education in K-12 curriculum!
• For contractors – change the law to require the hiring person to get a Form W-9 and electronically submit it to IRS and State tax agency. These agencies then check if the person has filed a Schedule C or equivalent form (W-9 requires taxpayer to note type of business entity).  If yes – likely nothing need be done.  If no, email and mail that worker clear information about their tax obligations as a new self-employed entrepreneur. Connect them to tax agency YouTube videos as well. Ideally, this could also be when the federal government deposits $500 into their new retirement account (or perhaps does that once the first return with the Schedule C is filed).
• Lower the Form 1099-K threshold to match Form 1099-MISC ($600). California should not wait for Congress to do this but should instead do what Massachusetts and Vermont already did and drop the threshold to $600. This will help workers and reduce non-filing and the tax gap. It will also mean that more folks renting their property through Airbnb and similar thresholds get a reporting form (and that the government does as well).
• The  IRS has an online withholding calculator for employees that freelancers can also use – but it only works if the taxpayer has wage withholding.  The IRS and FTB should create online calculators to make it easy to compute quarterly estimated tax payments (federal and state) and to pay them online even if a taxpayer doesn't have wage income.
• A gig worker testifying lamented that she would not be able to prove her expenses for mileage on her own but would have to rely on the information provided by Uber and Lyft. That's a great point.  Rather than duplicate the recordkeeping, I suggest that the tax agencies find a way to "certify" the platform's recordkeeping so that the workers can use that information for tax preparation without issue. This should also help the worker understand the information. For example, did the app also track miles  between a drop off and next pick up (it would be helpful for tax recordkeeping if it did).

What about AB 5 enacted in California in September that will cause all employers with California contractors to determine the classification standard under the ABC test. That test starts with the presumption that the worker is an employee. To see if they are not an employee, the ABC test is met requiring meeting each of the following 3 requirements:

  (A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

  (B) The person performs work that is outside the usual course of the hiring entity’s business.

  (C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If not met, next see if one of the roughly 50 exceptions in AB 5 is met.  If an exception is met, then apply the Borello factors which are basically the common law approach to see if the service recipient has the right to control the manner and means of how the work is performed. If the service recipient can control the manner and means, the worker is an employee; otherwise, is a contractor.

It is important to read the AB 5 exceptions carefully.  I have seen summaries that say accountants are excepted. That is far too simplified. The exception actually reads: "An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant." Like this one, more exceptions will raise interpretive issues such as what does "practicing" mean. In addition parts of the ABC test, particularly "B" will raise interpretive issues. Unfortunately rather than clarifying worker classification by using objective factors, AB 5 leaves us with mostly subjective criteria. 

The results of AB 5 are many but include:

• A worker might be an employee for California law but a contractor for federal. It will be very important for the worker and payor to understand the tax consequences. For example, there is no form equivalent to a Form W-2 that is only issued to a worker and the EDD and FTB (rather than also to the IRS and Social Security Administration); one will need to be created. While this different in classification is not new, it is likely to affect far more workers starting in 2020.
• A worker may continue to be a contractor for both California and federal but more documentation is needed to show that the work arrangement met the ABC test or met an exception.
• The worker is unfortunately out of a job because the payor doesn't want to hire them as an employee. I'm concerned that this may be the case for many part-time workers. The person presenting on October 1 from Postmates noted that many on the platform work just 3 to 5 hours per week and then only for about 3 to 5 months. It's a lot of work to hire these short-term workers as employees.  It is also possible that those hired will not get all benefits, such as offering of health insurance as they might be hired to work less than 30 hours per week with no legal requirement to offer coverage. And virtual workers might find that the employer prefers now to just use workers outside of California.
• And there are other possibilities - let's see what happens.

One additional tax compliance issue I raised involved freelancers that provide services to people outside of California, such as a virtual worker might who is consulting, providing graphic art services or tech services (such as Amazon Mechanical Turks provide). Like all of the tax issues, this is not unique to gig workers but any contractor or any-size business, what is the guidance for sourcing the income to California or other states - and what are the rules in other states. Unfortunately, this can be a complex tax issue not only for individual sole proprietors but also large multistate corporations.

So, lots of issues for compliance, not only for gig workers but other contractors PLUS new complications of the ABC test and its exceptions added by AB 5 effective 1/1/20. All employers with California contractors need to take a look at this legislation to see what changes. While the worker might still be a contractor, the service recipient (payor) will need new documentation to show that the person is a contractor beyond what was needed before 2020.

What do you think?  (btw, I expect to write more on AB 5 later as it is not an example of law changes that help move tax systems into the 21st century to reflect how we live and do business today. There are much better ways to actually get more safety net benefits and beyond to ALL workers.  Also, note that lots of employees don't get many benefits and have very low wages. I think we need to do more as a civil society to address levels of pay and safety net and retirement benefits for EVERYONE and there are ways to accomplish this!

60th Anniversary of P.L. 86-272

State Tax Notes, 9/5/19

Today, September 14, 2019 marks the 60th anniversary of the enactment of P.L. 86-272 dealing with nexus for net income tax purposes for a limited category of sellers (those selling tangible personal property). This legislation was intended to be temporary while Congress studied numerous state/multistate tax issues that went beyond the initial reach of P.L. 86-272. Despite lots of study and a 1,000+ detailed report with recommendations issued in the early 1960's, no change was ever made.

Meanwhile, issues continue to grow including exactly how to interpret P.L. 86-272 in the modern era with new ways of doing business.

I've got an article in State Tax Notes about this law and its issues and recent developments.  I was hoping not to have to consider even writing this article after I wrote an article in 2009 on the 50th anniversary.  There are proposals for change in each session of Congress and lots of commentary and analysis on nexus, including the U.S. Supreme Court's decision in Wayfair in 2018. But, still no update.

I hope you'll take a look at the article and post your comments on what you think should be the next step in providing useful and appropriate nexus rules for taxpayers and states.  See "Public Law 86-272 Reaches Its 60-Year Anniversary," State Tax Notes, 9/5/19. I've also updated the website I created for the 50th anniversary - here.

What do you think?

Two States Using Wayfair Economic Nexus Standard More Broadly

As we know, the June 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., et al, allows for an economic nexus threshold for all types of taxes. Many states already had an economic nexus threshold for income taxes. Many states have adopted the South Dakota threshold for nexus. This standard generally starts use tax obligations when a vendor has over $100,000 of sales in the prior calendar year or the current year to date or 200 or more transactions.

Now, one state - Hawaii, has adopted that same threshold for its state income tax effective for tax years beginning after 12/31/19.  [SB 495 (Act 221, 7/2/19)] Hawaii's sales tax nexus threshold based on the South Dakota law upheld by the Court started 7/1/18.

Also, the Texas Comptroller has proposed the same via a proposed regulatory change for its franchise tax. The Texas sales tax Wayfair threshold though is over $500,000 of sales and it doesn't matter how many transactions there are (there is only a dollar sales threshold).

Remember that a state cannot override P.L. 86-272 which still applies to limit nexus if a taxpayer has no physical presence other than sales personnel who solicit orders that are approved and shipped from out-of-state. This is relevant for Hawaii's state income tax, but doesn't apply to the Texas franchise tax because it is not a net income tax.

Making the thresholds the same should be a lot simpler for small businesses. I don't agree with the South Dakota threshold's 200 or more transactions because for many small businesses though because that can be a small dollar amount, such as if selling items that cost less than $10 each. I think that is not sufficient nexus for commerce clause purposes.  I think states should do like California and Texas did and drop the transaction threshold and only use a dollar of sales gross receipts that is at least $100,000 and perhaps higher in large states (after all, buyers not charged sales tax still have to pay use tax on their own, and the higher threshold keeps the burden on the state tax agency more manageable and more likely that most remote vendors will be found and have to collect.

Not all states define sales the same for these purposes so there is still complexity for multistate sellers. But for a remote seller to know that once they have use tax collection obligations in a state they also have income tax obligations (assuming they are not protected by PL 86-272), should provide greater certainty to businesses and state tax agencies and simplify recordkeeping.

What do you think?

Does TCJA Make C Corps Better?

Does TCJA Make C Corps Better? Generally no when you factor in double taxation of C corporations. I've got an article looking at this question but only looking at domestic tax rules. Certainly, lots of international activity might make the C corporation look better.  Here is the article, published this week in the Wealth Strategies Journal - https://wealthstrategiesjournal.com/2019/08/08/is-a-c-corporation-preferred-after-tax-reform/

What do you think?

Two New Sales Tax Exemptions in California for Two Years

California SB 92 (Chapter 34, 6/27/19) adds two new sales tax exemptions starting 1/1/20 and ending 12/31/21:

1. “diapers designed, manufactured, processed, fabricated, or packaged for use by infants, toddlers, and children” [R&T 6363.9]
2. “menstrual hygiene products” shall only include the following: (1) Tampons. (2) Sanitary napkins primarily designed and labeled for menstrual hygiene use. (3) Menstrual sponges. (4) Menstrual cups.” [R&T 6363.10]

For these new temporary sales tax exemptions, the legislature applies R&T §41 dealing with accountability. Thus, the legislature had to specify the purpose of the exemptions and require a report from the LAO on the effectiveness of these provisions including whether they should be modified, extended, or allowed to expire. For the diaper exemption, the LAO is also to assess “whether more targeted approaches to providing families in need with adequate access to diapers are available.” For the menstrual products, the LAO is also to assess “whether more targeted approaches to providing individuals in need with adequate access to menstrual hygiene products are available.” The specified goals of these exemptions:

·         Diapers: “to promote public health by increasing the affordability of, and expanding access to, diapers.”

·         Menstrual hygiene products: “to promote public health by increasing the affordability of, and expanding access to, menstrual hygiene products.”

Observation: Often, bills that provide a new credit or exemption state that R&T §41 does not apply. Then there is no need for accountability as to whether the provision meets its purpose or even that a purpose be articulated. Important to this assessment though is whether the LAO will have the information needed for a strong assessment. The legislation should have included a provision and funding to have the LAO identify information it will need the CDTFA to collect.

Other states provide similar exemptions with the sales tax on menstrual products sometimes referred to as the pink tax or the tampon tax. States with an exemption include Connecticut, Florida, Illinois, Minnesota, New Jersey and New York.

Do these exemptions reflect good tax policy? NO. The biggest issue is equity and fairness in that they give the largest break to higher income buyers because they are likely to spend more on diapers. I see that on Amazon, diapers range from 11 cents/diaper up to at least 49 cents/diaper. Someone already buying the more expensive diapers doesn't need a sales tax break to make diapers more affordable as they have already opted to not buy a less expensive diaper that would be more affordable. If the exemption were only given to individuals who need it and who may need even more assistance in paying the price without the sales tax, this exemption is poorly targeted.  A similar argument can be made for the menstrual products.

There are better ways to target relief to taxpayers needing relief rather than also giving relief to those who don't need it. This sales tax break results in reduced revenue for state and local governments. How will they make it up?

More targeted relief would be to provide diaper coupons to individuals already receiving state or local aid, or just giving them diapers which the state would buy in bulk at a reduced cost. Same with menstrual products.

Another concern with these products is that there are added environmental costs of these disposable items. Thus, removing the tax on them means that the costs of disposal and filling up landfills needs to come from elsewhere.

What about the argument that only females need menstrual products so taxing them is a gender disparity. That same argument can be made for other products such as razors, shaving cream, jock straps, football helmets, and I'm sure other items. Exempting these items makes the system more complex, less equitable, and requires that the rate be higher on other items.

The California Legislative Analysts Office issued a report (5/12/19) on these exemptions before enactment of S 92. It notes a few additional issues including the difficulty of defining a "necessity" and whether an income tax credit for the menstrual products would present greater tax relief.

What do you think?