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. A video of the meeting is available.

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!

Revenues and customers can still be a hobby

For a few years, I have noted in update presentations and elsewhere that some gig drivers who only drive occasionally, do it for cash generation or to pass the time, or have other income sources, might really have an activity not engaged in for profit ("hobby"), rather than a business. The tax consequences of the hobby designation are tremendous in that no deductions are allowed starting in 2018. No self-employment tax is owed either, but loss of tax deductions for a gig driver is costly.  Following is an example of a taxpayer with revenues, customers and a business premises who was found not to be engaged in a business.

Revenues Not Enough to Indicate Business – Ford, TC Memo 2018-8 (1/25/18), aff’d No. 18-1524 (6^th Cir., 11/5/18, not for publication) – F used to be recording artist and spend most of her life promoting and performing country music. For the years under exam -  2012 through 2014, she owned and operated the Bell Cove Club in Tennessee on her own. Earlier, she and her husband operated this club (starting in 1986) and wanted it to be a place where artists could perform for talent scouts and producers. It closed when her husband died in 1999 but Joy reopened it in 2008. Customers only had to pay $5 for admission and a small amount for food. F paid performers. Losses were generated. F had some plans she pursued to convert the club into a restaurant or televise the performances, but these changes did not materialize. The IRS disallowed the losses finding the club not operated for profit. The court agreed finding the club was operated mostly for personal pleasure rather than profit with the losses offsetting investment income of F.

F appealed to the 6^th Circuit which upheld the Tax Court decision as it did not find any error in that court’s analysis. At the start, the 6^th Circuit notes:

“’Find a job doing something you love.’ Perhaps that is sound advice.  But deducting business losses from your taxes when you are not trying to profit from the business you love is not a sound strategy.  Here, the Tax Court found that the appellant did just that: ran a business doing something she loved, accumulated substantial losses, and deducted those losses from her income. Because the court below did not commit clear error in making this determination, we AFFIRM.” The court re-examined the factors under Reg. 1.183-2 that help distinguish a business from an activity not engaged in for profit and concluded that the club wasn’t operated in a for-profit manner. For example, the court noted that Ford did nothing to reduce costs, leaving empty refrigerators and stage lights running even when the club wasn’t open for business. Also, she did not adjust the cover charge to help make a profit. In addition, she did not want to serve alcohol, but let patrons bring in their own. Per the court: “The record paints a picture of a business operated without regard to cost or profit. There is nothing indicating Ford operated in a “business-like manner.””

Observations: The Tax Court generally applied Reg. 1.183-2 without going through a detailed analysis of each of the nine factors. In contrast, the 6^th Circuit analyzed each of the nine factors. But both courts concluded that the club was an activity not engaged in for profit (a hobby). Often, we think that an activity with customers and revenues is automatically a business. But more is needed under IRC sections 162 and 183 and the regulations and court cases. Today, this issue can arise with some occasional, part-time gig workers. They generate income from, for example, using the Uber or Lyft platform, but do not set prices, have no business plan, do not regularly engage in the activity, do not have separate financial records, may be doing the activity to generate cash for bills and/or pass the time. These individuals may fall into the same situation as Joy Ford. A tax adviser can help these individuals to convert their hobby or activity at risk of being a hobby into a business by following the Reg. 1.183-2 factors to make the activity a business. After the TCJA, a hobby means all of the revenue is reported, but no deductions are allowed.

What do you think?

Gig Workforce and Portable Benefits

On May 25, 2017, Senator Warner (D-VA) and Congresswoman DelBene (D-WA) introduced H. 1251 and H.R. 2685, Portable Benefits for Independent Workers Pilot Program Act. It calls for $20 million of grant dollars for states to study and pursue innovative ways to provide portable benefits to "the growing independent workforce."

Per Senator Warner: "Whether by choice or necessity, a growing number of Americans are working without a safety net and have difficulty planning and saving for retirement, health care needs, or on-the-job injuries. The nature of work is changing rapidly, but our policies largely remain tied to a 20th century model of traditional full-time employment.” “As more and more Americans engage in part-time, contract or other alternative work arrangements, it’s increasingly important that we provide them with an ability to access more flexible, portable benefits that they can carry with them to multiple jobs across a day, a year, and even a career. These incentive grants will accelerate experimentation at the state and local levels to better support a more independent 21st century workforce.”

This is a good idea, but puzzling as to why they don't address this at the federal level given the number of provisions regarding workers that exist at the federal level. For example, only employees get unemployment benefits, not contractors. Retirement plans differ for employees versus contractors. Why not modify these rules to address the fact that even if someone is an employee rather than a contractor, they will have numerous employers over their careers. They all need portable benefits.

Why aren't federal tax reform discussions also focused on trends and modernization of our tax system?

What do you think?

Worker Voice, Classification and Taxes

Source: https://www.whitehouse.gov/campaign/worker-voice

Last week (10/7/15), the White House and Department of Labor held the White House Summit on Worker Voice. Per the event's website, this event "provided a historic opportunity to bring together a diverse group of leaders – including workers, employers, unions, organizers and other advocates and experts -- to explore ways to ensure that middle-class Americans are sharing in the benefits of the broad-based economic growth that they are helping to create."

President Obama's remarks included this reference about the "sharing economy":

"We’ve got folks who are getting a paycheck driving for Uber or Lyft; people who are cleaning other people’s houses through Handy; offering their skills on TaskRabbit.  And so there’s flexibility and autonomy and opportunity for workers.  And millennials love working their phones much quicker than I can.  (Laughter.)  And all this is promising.  But if the combination of globalization and automation undermines the capacity of the ordinary worker and the ordinary family to be able to support themselves, if employers are able to use these factors to weaken workers’ voices and give them a take-it-or-leave-it deal in which they don't have a chance to ever save for the kind of retirement they're looking for, if we don't refashion the social compact so that workers are able to be rewarded properly for the labor that they put in... -- then we're going to have problems.

"And it’s not just going to be a problem for our politics -- creating resentment and anxiety -- it’s going be a problem for our economy because the history shows that when we do best as an economy it’s when workers have money in their pockets and they're able to buy goods and services.  And they, in turn, create new demand, and create new opportunity, and create the kinds of markets that businesses can then take advantage of.  That's just a fact.

"So we’ve got to make sure that as we continue to move forward, both in this new “on demand” economy and in the traditional economy as a whole, hard work guarantees some security.  And that's what this summit is about -– making sure that, as our economy continues to evolve, working Americans don’t get lost in the shuffle.  They can come together and they can win.

"And we can do this.  We’ve done it before.  There was a time when we shifted from an agrarian economy to an industrial economy.  And as we did, we made some adjustments to our arrangements.  We said, you know what, we’re going to offer everybody a free public education.  We put together the New Deal, put in place systems like Social Security so that people had some basic protections in their golden years.  We put together labor laws that allowed for collective bargaining, and banned child labor, and allowed people to raise their voices and have some leverage in seeking a living wage."

Well, that's a lot!  Much of his remarks also focused on unions and the need for workers to have ways to organize and not be precluded from doing so by employers. Per President Obama: "At a time of shrinking union membership, but a growing number of digital tools for organizing, how do we make sure everyone who works hard has a chance to get ahead? "

One of many things the "on demand" economy needs is more clear and consistent rules on worker classification. That wasn't mentioned in the president's remarks. He did list six things that workers need:

1. To earn enough to support a family.
2. To earn "decent benefits."
3. A safe workplace and benefits should you be injured on the job.
4. Family benefits - sick leave, parental leave, affordable child care and predictable work schedules.
5. A way to obtain education and training to grow your skills to move ahead.
6. Freedom to decide if you want to join with others, via a union or other means, to advocate for yourself.

What does all of that mean in the "gig" / "on demand" / freelancing economy? Here are some of my suggestions:

1. Ease of creating your own business that will be respected as an independent business without fear that the government will reclassify you as an employee for any purpose.
2. Simpler retirement plan rules so it is easy to set up an account and contribute to it regularly. Today, there are too many choices.
3. Greater access to free training to help one grow their business.  The SBA and some state agencies offer such classes. Perhaps more is needed.  I think this should be a required course in high school (perhaps 6 weeks).
4. The ability to pay into a "training / emergency" fund tax free.  A percentage of one's income (up to a specified limit) can be paid into this account. Workers can draw upon it should they experience a downturn in work or need to take time off for training or family needs). Perhaps they could apply for a partial match from a government account based on need.

What do you think?