What’s the Gig Deal? Part 2
What’s the Gig Deal? Part 2 In this second installment looking at the gig economy, Tom dives into worker status. Should they be classified as an employee or as an…
February 22nd, 2021
The number of people working “gig” jobs, such as food delivery and driving for ride-sharing services, certainly seems to have gone up during this time of COVID. Tom discusses using the 9 factors to determine if these activities are considered a hobby or trade or business in the eyes of the IRS. He also discusses what to do if your client receives a 1099-NEC.
by Tom O’Saben, EA
This gig economy has grown to the point where the IRS actually has a dedicated website. I’m giving you the link right here on the slide. You can go to that your leisure, and see what information IRS has available for you. On the gig economy website at IRS, they give us some examples. And these are not all inclusive, but they’ll get your juices flowing as to some clients that you might consider that are doing these. Driving a car for booked rides or deliveries… I have a client who is doing this. He’s not assigned with with Uber or Lyft or any of those, he does it on his own. He’ll drive people to the airport, he’ll drive people to doctor’s appointments, etc. He’s doing it to make money. Renting out property or part of it… Last year in Fall Tax School, we used an example in our unusual items of income and expense chapter, where we describe someone perhaps, who lives near a facility where they’re going to have a PGA tournament. They rent out a room for a couple of weeks, or parking spots in their yard. I experienced that also when, some years back, went to the NFL Hall of Fame. I wanted to see Kurt Warner, you might remember Kurt Warner from being a St. Louis Ram. Anyway, when Kurt was being inducted into the Hall of Fame, I noticed all the homes around the Pro Football Hall of Fame area had people renting out parking spaces and their yards. Again, that would be something in the gig economy. Running errands or completing tasks… Just like the gentleman I just described. He would be happy to run to the grocery store, maybe go to someplace to pick up something for a client. Selling goods online… really, really big. People selling things on eBay. And it’s a big deal in Illinois. From the issuance of the Form 1099K, the state of Illinois, which is where we are, has a much lower level of compliance for the issuance of 1099Ks. So you’ll have folks that just did a few transactions…that 1099K is probably going to be issued, not because of federal guidelines, but because of state guidelines. You have persons that are renting equipment. Providing creative or professional services…I’m aware of at least one hairdresser that I know that makes house calls. Providing other temporary on demand or freelance work that people might be needing. Continuing on from some information that we have on the gig economy website at IRS.gov… they talk about digital platforms. I’d not heard that term before. But I guess, when they’re talking about ride sharing services or delivery services, that’s where we get into our Uber and Uber Eats and Instacart, delivery services, crafts and handmade item marketplaces, could be websites, on demand labor and repair, or perhaps property in space rental. This is not an all inclusive list. But certainly ones that the IRS mention at the gig economy webpage that they’ve built. And also meant to get your juices flowing and thinking about clients that you might have involved in these types of activities.
So once again, I say so what’s the gig deal? Aren’t these just self-employed persons like anybody else? And we’re going to talk about what was your income? What was your expenses? Well, I guess the first thing we have to concern ourselves with, and that’s what I put here at the beginning of this slide… assuming they’re not actually employees. You may recall that it was either last summer or last fall, where the state of California wanted to pass legislation to say that Uber drivers are, in fact, employees of Uber, and then have all the employment requirements to deal with. Well, the legislation didn’t pass by the way, but you can see the direction they’re going. Now, we’re not going to spend time in this blog on differentiating an employee from an independent contractor. But you certainly know that there are circumstances where you have someone who comes in to see you, a taxpayer, and they are surprised that they didn’t have any taxes withheld. And then you begin to ask them questions to see whether or not they’re truly an employee versus an independent contractor. I think we’ll do that in a in a future blog. What I want to concentrate on in this session, is the discussion about whether or not the activity is engaged in for profit, a truly self-employed situation? Or is it in fact, a hobby. So when dealing with the persons that are self-employed, it’s no different with a gig job than it is with any other activity. How about reasonable and necessary business expenses? Things like mileage, office expenses? What are they using to get their appointments? Aren’t they using a cell phone? Wouldn’t there be a portion of that that could be deductible? Could we make an argument, perhaps, for office in the home? It’s entirely possible. The bigger question is, is the activity actually being engaged in for profit or is it a hobby? That’s what I want to concentrate on in the time we have together today.
Here we go. So is that activity engaged in for profit or is it a hobby? For those of you who have known me or have listened to blogs or Fall Tax School or webinars that I may have done…I get into the nine factors all the time. The nine factors are not new. I’m going to have them reproduced here for you in just a little bit. Asking our clients these questions becomes paramount to whether or not the client is engaged in the activity for profit. Normally, we’re having this conversation with a client to determine whether or not losses would be deductible. That’s a good point to think about, right? But let’s talk about these nine factors first. I’m giving you another link here, because again, not new, but I thought it would be important that you don’t have to just listen to what Tom O’Saben says. Let’s go ahead and consider listening to what the IRS has to say when we’re talking about items, for example, like the nine factors. There’s another link for you to follow, if you want to go and see what the horse’s mouth has to say. So the first thing we talk about is a question posed at IRS.gov. How do you distinguish between a business and a hobby? This is IRS talking now. The answer? In making the distinction, take into account all facts and circumstances with respect to the activity. All facts and circumstances. We need to talk to the taxpayer. A hobby activity is an activity not done for profit. This includes activities done mainly for sport. Although I’d like to see the IRS argue that a NASCAR driver is in an activity engaged in for profit, again, facts and circumstances, or recreation or pleasure. No one of these nine factors alone is decisive. I added the emphasis there…that emphasis is not there in the information that you see at the IRS website. So let’s talk about these nine factors. Again, they’re not new. And if you you’ve had any conversation with me before, you know that I’m a huge believer in these nine factors, not just because of what the IRS says, but what I’ve seen in Tax Court cases where the issue comes up. Is the activity engaged in for profit? Or is it in fact a hobby? So you look at those and again, you’ve heard these before: Are they acting like a business? Do we have books and records? Are there personal motives in carrying on the activity? What is the time and effort that you’re putting into it? I had this come up with an auditor a long time ago…could’ve been 25 years ago. He was looking at the 500 hours, which are really material participation hours. But we had a discussion about how much time was being involved in the activity. Does an individual depend on the income from the activity or are they expecting that they will? Are the losses due to circumstances beyond their control? Like in a startup situation? Or how about because of COVID where you see sales drop off dramatically? Restaurants closed… bars shut down…limited engagement with people. Here’s some other of the nine factors: Whether you or the advisors have knowledge needed to carry on the activity? Are you learning about this business? How have you been in the past with other activities? Or do you just lose money? Does the activity make profit in some years? And how much profit does it make? You know, that issue always comes up… Oh, I can’t show losses more than two years in a row, or it’s going to be recategorized as a hobby. Ladies and gentlemen, that is one factor. If the other facts and circumstances support that the activity is engaged in for profit, then I really don’t care how many years a client has losses. Furthermore, I’ll say this: Look at the profitability of the business before the depreciation, section 179 and bonus deduction you’re taking. You might find that the client is in fact profitable, and only isn’t showing a profit because of the deductions we’re taking. Also, that will give you an opportunity to also discuss with the client — I just had this conversation the other day — if we’re going ahead and taking bonus, maybe we worry that we’re showing too much of a loss in one year. Should we opt out in order to use regular depreciation? The ultimate decision is up to the client. But I’m going to tell you, I don’t care if other factors are met, whether or not the client is showing a profit. How about whether you expect to make future profit from appreciation of assets? You have someone who maybe start a tree farm, for example. Well, we’ve got a lot of investment upfront. The benefit is going to be reaped down the road. Not too many people sell saplings during the holidays, right? I might throw an aside in here. Did you know there was a Christmas tree shortage this past Christmas? Because I guess with so many people being in their homes, they spent more time on decorating. So interesting when you look at that. So there’s the nine factors. IRS also suggests, and I think it’s a good suggestion, that if you want to go further, you don’t have to listen to Tom O’Saben; you don’t have to listen to an IRS website. Go to the reg 1.183-2b of the federal tax regs. Put that into your Google machine and take a look at that to feel better, or more convinced about what I’m I’m having to say. And by the way, ask this of your client on an annual basis because clients circumstances, in fact, change. But we say in addition to these nine factors, does the activity have continuity and regularity? Think about that…continuity and regularity. So once again, as my theme kind of is in this section I’m doing with you today, let’s go to the IRS instructions for Schedule C. Right here from the instructions: “an activity qualifies as a business if your primary purpose is to make a profit.” Okay, but look at the word and that’s right there… “and you were involved in the activity with continuity and regularity.” I added the bold; the bold is not in the instructions from the IRS instructions for Schedule C. I wanted you to see that… “and continuity and regularity.” So the point I’m trying to get through to you is kind of a mindset. Could we have profit and the activity not be engaged in for profit, because it lacks continuity and regularity? Stay tuned.
Here’s an example. This is from IRS. A sporadic activity, not for profit or a hobby doesn’t qualify as a business. This doesn’t mean we don’t have to report the income. It just means we’re not going to put it on a Schedule C; we’re going to put it on Schedule 1 of the 1040, line eight, which is our other income line. That doesn’t mean it’s not taxable income. It just means it’s not engaged in for profit with continuity and regularity. And I say here if the activity does lack continuity and regularity, then you likely have a hobby. What’s a pro of this? I’m going to say: no self-employment tax. But how are we going to determine continuity and regularity? Does it if I only drive once a month for Uber, does that lack continuity and regularity? When I’ve been doing it for two years, I think we have continuity and regularity. How about another circumstance where someone says, “you know what, I did this for a month, and I absolutely hated it. And I’m never doing it again.” I think you could argue that it does lack continuity and regularity. Alright, we’ll talk about how to handle that in a little bit. So we could have profit, but we don’t have an activity engaged in for profit. So possibly, we have no self-employment tax. What’s the downside if we’re going to call it a hobby? We’ve got limited deductibility of expenses. We’re going to have to report the income, like I showed you in a previous slide, where we’re going to be on Schedule one, line eight. Then all we can do in deductions is a reasonably and consistently allocated cost of sales. We take that directly against the income. But our other expenses like office expenses and such, those would end up being miscellaneous itemized deductions on Schedule A. But what did TCJA do to those miscellaneous itemized deductions? They’re gone. So not that you’re going to coach a client to go to the same way, but you can see with every zig there’s a zag. So if we’re going to argue that an activity lacks continuity and regularity, no SE tax. Conversely, are we going to be stuck in a situation where we’ve got income to report and very little in the way of expenses, other than again, a consistently and reasonably allocated cost of sales. Well, can a tax payer shift from year to year? Can circumstances change? You know how people get all excited about doing an activity, and then the blush goes off the rows as the same as the saying goes. So you could have someone, for example, get involved in Instacart. They love it. They’re doing it every week, they love seeing people and dropping off the groceries. And they’re doing this for a couple years, and they think they’re doing really, really well. And then they decide that they kind of lost interest.
The dew was off the lily is what I think I was trying to say before. And you find that we’re three or four years down the road. They say, “you know what? I turn down most of the requests, and I’ll do it maybe once in a while.” Is it possible that that activity that you’ve been treated as being conducted for a profit motive with continuity and regularity, now has lost its continuity and regularity going forward? It’s entirely possible. Entirely possible. What do we have to do? Consider facts and circumstances and talk with our client.
So here’s another what to do area… a client does drive for Uber, for example, and receives a 1099NEC. You know, that’s a new form this year in 2020, you’re already seeing them. We don’t have that box seven anymore on a 1099-MISC to deal with non employee compensation. No, it’s got its own form: 1099-NEC. NEC, meaning non employee compensation. But we determined that the activity lacks continuity and regularity but here we’re sitting with a 1099 NEC, or perhaps a 1099 K, like I described, for people selling things on eBay, for example, and the Illinois requirement being so small, we have to report it. We can’t just ignore it. Here’s my advice: start out on Schedule C. Enter that gross income there. If you determine that that activity does not have continuity and regularity, then I want you to take that same number, that gross income, and put it into other expenses. You know, where you can type out on that line, say something to the effect of “activity not engaged in for profit, see Schedule one, line eight.” And put that same number in as an expense, which is going to zero out your Schedule C. You still have to report the income; it doesn’t make it tax free. We’re going to report that then over on Schedule one. A couple things it’s going to do from a matching standpoint… IRS is going to see the 1099 K or the 1099 NEC. They’re also going to see that the Schedule C zeroes out. So they’re not looking for self-employment tax. I will guarantee you 100% of the time that there’s an entry on a 1099 NEC. Barring deduction for expenses, the IRS will be looking for self -employment tax. That’s why I’m telling you it ought to be on a Schedule C. Back off that income as an expense; activity non engaged for profit. Go and report the income on Schedule one, line eight. Do it with the form. The IRS works with forms; don’t try writing letters. It doesn’t work, in my opinion. If there’s a form, then use a form.
So hopefully this gives you some information to consider when talking with your clients about the gig economy. I think we’re all into a situation where it’s a brand new world here in 2021. And clients are doing things that they haven’t done before. But more than anything, we need communication. That’s the real key. Talk with your client and document what you’ve done. Then I think you can have a happier client and a happier tax season going forward. So I wish you well. I hope you’re enjoying these video blogs. From all of us here at the University of Illinois Tax School…this is Tom O’Saben, saying goodbye again for just a while.
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