Tax rules in the sharing economy need work

By Joyce Beebe, Ph.D.
Fellow in Public Finance


During the first quarter of 2019, the hype about Uber and Lyft’s race to become public companies initiated discussions on everything from Uber’s whopping $120 billion and Lyft’s $24 billion pre-IPO valuation to the fact that both companies are still deeply unprofitable. Several months into being public companies, both have experienced rollercoaster stock prices and lower valuations: post-IPO, the market values Uber at approximately $74 billion and Lyft at roughly $18 billion. The turbulence apparently did not stop other IPO hopefuls: Postmates has filed for an IPO and is exploring other exit strategies, whereas Airbnb is contemplating its own public floating. Throughout the period, little attention has been paid to how these IPOs could affect tax collection for governments, given the complex tax rules governing drivers and other workers in the rapidly evolving sharing economy.

The sharing economy is a phenomenon that practically did not exist a decade ago but has become increasingly widespread in large cities like Houston. Companies operating in this industry and policymakers would be well-served to address the tax question now if they want to avoid serious headaches down the road.

Companies participating in the sharing economy operate as online intermediaries that use app- or web-based software platforms to match suppliers and consumers of goods or services. Besides ride-hailing services, many people are familiar with home-sharing platforms (e.g., Airbnb and HomeAway), general freelance apps (TaskRabbit) and peer-to-peer sales sites (eBay and Etsy). There are many more consumers than suppliers in today’s sharing economy, and most workers participate in this sector to earn secondary income to supplement their primary income.

The sharing economy has introduced various benefits and challenges. For workers, its most praised features are work schedule flexibility and the ease of getting work; for consumers, services like Uber and Airbnb offer additional options and lower prices relative to taxis and hotels, respectively, However, some platform companies — including Uber — have been battling lawsuits regarding the status of workers as employees or independent contractors. This matters because employees are more likely to be subject to wage and benefit protections that are not available to non-employees. In other words, classifying workers as independent contractors instead of employees improves a platform company’s bottom line.

The non-employee classification has three major tax implications: the lack of employer withholding, the payment of self-employment taxes, and the deduction of business expenses. A company that hires contractors does not need to withhold income taxes or pay workers’ FICA (Federal Insurance Contributions Act, which finances Social Security and Medicare) and FUTA (Federal Unemployment Tax Act) taxes. Workers shoulder most tax obligations themselves: they are not only responsible for a 15.3% self-employment tax but also need to file quarterly estimated income tax payments to avoid penalties, in addition to preparing annual filings to reconcile their tax liability.

For tax purposes, sharing economy workers are self-employed and treated similarly to small business owners. As such, workers must keep receipts of expenses to secure business expense deductions and the resulting taxable income. This means that Uber drivers need to record miles driven between passengers, parking expenses, payments for car washes, toll fees and gas purchases. Airbnb hosts need to keep track of cleaning, maintenance, repair, property tax and insurance expenses.

Another challenge comes from the convoluted tax rules that apply to sharing economy workers. Plenty of research shows that sharing economy workers have at best a fuzzy understanding about how they should report their income for tax purposes. This has a lot to do with the complexity and ambiguity of current tax rules. The long-term consequence of imposing overly complicated tax rules on large numbers of small taxpayers would be lower tax compliance, and thus lower tax revenue for governments. A recent Treasury analysis revealed that at least 25% of sharing economy workers, mostly Uber drivers, failed to report their income accurately, leading to billions of lost revenue annually.

At present, if a company pays an independent contractor more than $600 for services performed, it must issue Form 1099-MISC to both the IRS and the contractor. But a separate rule requires banks, credit card companies and “third-party settlement organizations” to report payments to each payee on Form 1099-K, and only if the payment exceeds $20,000 and the aggregate number of transactions is over 200. Some platform companies therefore claim they can use the higher reporting threshold under Form 1099-K because they process customers’ credit card payments and make payments to providers through a central account.

This well-documented Form 1099 discrepancy has prompted varied approaches to compliance by companies such as TaskRabbit, Uber, Lyft, Airbnb and Etsy. Given the confusion many sharing economy workers have over how to properly fulfill their tax obligations, it is possible that a worker who earns less than $20,000 from a platform company and does not receive a tax form, or who earns less than $20,000 from each platform company he works for but earns more than $20,000 collectively from multiple platform companies, will underreport income.

The novelty and evolution of the sharing economy has introduced social, commercial and legal challenges. It also puts pressure on the existing tax system. Policymakers have begun to take steps to study and manage these tax-related issues, especially regarding the implications of self-employment status, lack of withholdings, and Form 1099 inconsistencies. Researchers recommend simplifying the current compliance process by offering a standard deduction amount for business-related expenses instead of keeping itemized receipts, similar to the U.K.’s £1,000 tax allowances. Meanwhile, court rulings in pending cases will likely have decisive implications for worker classification and tax collection, and the effects can take years to unfold.

However, if the whirlwind of tech-unicorn IPOs are any indication, it is increasing likely that today’s workers will experience a mix of traditional and independent work arrangements over the course of their careers. Public policies in this area could have profound implications for the future workforce and tax administration.