Drive for Uber? Deliver for Amazon? Here are tax rules to know
The nasty secret of being a new entrepreneur is that your tax bill might be way higher than you'd imagine.
When you're driving for Uber, delivering for Amazon, picking up freelance jobs or otherwise participating in the gig economy, you aren't working for a boss who is required to withhold taxes from a regular paycheck. As a result, you're subject to some fairly complex tax rules.
On-demand workers don't have the luxury of only paying attention to income taxes in March or April, either. If you don't pay enough taxes throughout the year, you could be hit with steep penalties.
About 24% of American adults earned money selling something online, renting out their homes or spare rooms, or taking on a job, such as driving for a ride-hailing service, according to a Pew Research Center study issued in 2016.
But how much do they know about the relevant tax rules? About 34% of those reporting earning income in the sharing economy did not know they needed to file quarterly estimated tax payments, according to Nina Olson, the National Taxpayer Advocate, in a testimony in Washington, D.C., in 2016. The figures were based on a National Association of the Self-Employed survey.
And about 43% did not set aside money to meet their tax obligations or know how much they owed. At tax time, the gig economy triggers plenty of bewildering questions for filers. So, where can an Uber driver make a wrong turn at tax time?
Should I pay taxes as I work somehow during the year?
For the first time in your life, you could be required to pay quarterly-estimated taxes on the money you're making as an independent contractor. And you're looking at paying self-employment taxes involving Social Security and Medicare.
"Many taxpayers — especially first-time independent contractors — don't realize they owe both income and self-employment taxes," said Caroline Bruckner, managing director at American University's Kogod Tax Policy Center, which researches tax issues specific to small businesses and entrepreneurs.
Quarterly-estimated tax payments are required when a taxpayer is expected to owe at least $1,000 in tax.
And it's usually the taxes connected to Social Security and Medicare that trip up workers in the gig economy.
For example, someone who earns just $7,500 per year driving for a ride-sharing company owes potentially $1,059.72 in just Social Security and Medicare taxes. And that alone would trigger quarterly-estimated filing requirements, Bruckner said.
"While folks may realize they're going to owe federal income taxes on their income, they don't necessarily plan on self-employment taxes and miss making quarterly-estimated payments," she said.
Underpaying your taxes during the year has consequences, which can include penalties and interest. The U.S. tax system is considered a pay-as-you-go system.
More taxpayers are getting slapped with penalties relating to underpaying estimated-taxes during the year. About 10 million people paid such penalties in 2015 — up 39% from 7.2 million people in 2010. The penalty amount varies, but can be several hundred dollars, according to the Internal Revenue Service.
An employee can adjust a W-4 form to have more money withheld from a paycheck. But someone who has a side job or only works as an independent contractor could need to pay quarterly-estimated taxes.
The Internal Revenue Service has its own "Sharing Economy Tax Center" online at www.irs.gov to explain various tax rules.
What forms do I need?
Ride-sharing services such as Uber and Lyft treat their drivers as independent contractors, said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting in Riverwoods, Ill.
"The income they earn is taxable whether they receive a 1099 or not. Sometimes they may receive a 1099-MISC, a 1099-K or nothing at all," Luscombe said.
In general, business owners issue a Form 1099-MISC to those workers who were paid at least $600 in rents, services performed by someone who is not your employee, prizes and awards, or other income payments.
Even if you did not receive a 1099-MISC because you earned less than $600, you're still required to report your earnings.
Some workers in what's dubbed 'the sharing economy" also could be looking at a Form 1099-K.
The Lyft website, for example, notes that drivers who earned at least $600 in gross ride receipts from passengers in the last year will receive a Form 1099-K. And drivers who earned at least $600 from activities other than driving, including bonuses or other incentives, in the last year will receive a Form 1099-MISC.
Under the current tax rules, if a person is paid electronically by credit card, debit card or third parties, such as PayPal, those payment networks would be required to issue a 1099-K when the taxpayer is paid at least $20,000 or more and has more than 200 such transactions.
"Most gig workers on average earn well below $20,000 and as a result, aren't getting any Form 1099-K and don't realize they even owe taxes on the income they earned," said Bruckner.
Bruckner said the IRS has found that there's a 60% likelihood that a taxpayer will misreport income if no taxes are withheld from paychecks or no tax documents, like a 1099 or W-2 form, are issued.
Yet if you are under age 65 and single, you must file a tax return if you earned $10,400 or more in 2017.
Dependent children who earn more than $6,350 of income in 2017 must file a personal income tax return and could owe income taxes.
Some people with income below those limits might want to file a tax return if they are due a refund, particularly if taxes were withheld.
What kind of tax breaks can I get for my expenses if I am self-employed?
Nathan Rigney, senior tax research analyst at The Tax Institute at H&R Block, said too often people who are new as self-employed drivers or other jobs in the sharing economy do not maintain good records of income or expenses.
"Even something as simple as tracking business mileage, which can be a significant expense, is often ignored by new gig economy participants who aren't yet aware of the tax savings those records provide," Rigney said.
Other expenses to track: Cellphone use for work, oil changes, supplies, health insurance premiums, fees paid to the app or website operator involved with the business.
But all your expenses won't necessarily generate a deduction. Luscombe noted that indirect expenses may require you to allocate for tax purposes between what was spent on business and personal use. So if you use a cellphone for personal calls, you need to take that into account.
If 25% of your time on the phone is spent on business, you may be able to deduct 25% of your phone bill.
Starting on 2018 tax returns, freelancers and on-demand workers will want to pay attention to the new Qualified Business Income deduction, which has some specific limitations.
"Gig operators may qualify for the new 20% deduction from qualified business income," Luscombe said.
But he noted that the 20% deduction would not include investment income or reasonable compensation, Luscombe said.
Right now, the definition for "reasonable compensation" is up in the air when it comes to a sole proprietorship. The IRS may address that issue at a later date, and if so, it could reduce the amount of income that would qualify for the 20% reduction, Luscombe said.
Under that new deduction, business owners can deduct 20% of the qualified business income if the taxable income they report on their personal returns does not exceed certain thresholds.
The qualified business income deduction would end after tax year 2025.
Remember, the process for complying with making estimated tax payments can be cumbersome — including oddly spaced payment deadlines of April 15, June 15, Sept.15 and Jan. 15 of the following year.
"These services make it very easy to become a driver or rent out a room but it doesn’t end when you get that direct deposit payment. You must take the extra steps to figure out and pay your tax obligation," said Luis D. Garcia, a spokesman for the IRS in Detroit.
Contact Susan Tompor: email@example.com or 313-222-8876. Follow Susan on Twitter @Tompor.