Shortchanged

The Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy

 

Written by Caroline Bruckner,

Managing Director, Kogod Tax Policy Center

Executive Summary

The last time Congress enacted substantial tax reform—in 1986—only 8.2% of American households owned personal computers. Today, more than 87% of American adults own a mobile phone and on-demand platforms like Uber, Etsy, Lyft, Airbnb, HomeAway, Amazon, and TaskRabbit have become household names by connecting businesses and consumers. Although millions of Americans are engaging in the on-demand platform economy every day as sellers and service providers, the tax compliance challenges this new frontier presents have gone relatively unnoticed. At the same time, these challenges will grow with this fastest growing segment of the labor economy—creating unnecessary and ongoing burdens for the small business operators who power the on-demand economy.

This report, in keeping with the mission of the Kogod Tax Policy Center to conduct non-partisan research on tax issues specific to small businesses and entrepreneurs, identifies the tax compliance challenges the on-demand economy presents for its small business operators. Having spent more than a year investigating this growing problem, we report that:

  • More than 2.5 million U.S. taxpayers are participating in the on-demand platform economy as small business owners every year, and that number is set to more than double in the next few years.
  • At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. In addition, these taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income and inconsistent reporting rule adoption.
  • The current tax administration system isn’t working for a significant percentage of these small business taxpayers or Treasury or IRS. The existing tax rules effectively create a $19,399 reporting tax loophole impacting millions of taxpayers (the difference between the income thresholds triggering Forms 1099-K and 1099-MISC reporting), resulting in widespread confusion among taxpayers.
  • The current state of play is one of unnecessary burden, potential audit and penalty exposure for on-demand platform economy players. We can do better.

Introduction

The last time Congress enacted substantial tax reform—in 1986—only 8.2% of American households owned personal computers.1 In 2014, 87% of American adults owned a mobile phone, of which 71% were smartphones (Internet-enabled).2 Companies like Uber, Etsy, Lyft, Airbnb, HomeAway, Amazon, and TaskRabbit have become household names by connecting businesses and consumers through online and appbased platforms. In the past 10 years, the Internet and smartphones have fundamentally changed the way Americans purchase goods and services in cashless transactions. Today, we book travel with our thumbs.

Since its launch in 2008, Airbnb hosts have accommodated more than 60,000,000 guests worldwide. In the United States, the overall Airbnb host community has grown 85% year-over-year, with the typical host earning $7,350 in supplemental income per year on just a single property.3 As of February 2016, Uber reported that it has more than 500,000 drivers, who earned more than $3.5 billion in take home wages in the first three quarters of 2015.4 Data from the first major study of the “on-demand platform economy” using financial transactions found that in the last three years, an estimated 10.3 million people earned income from being either service providers or sellers using an online platform intermediary.5

More than 2.5 million Americans are earning income by renting rooms, giving rides, running errands, and selling goods as small business owners every month.6 What’s more, the explosive growth of the on-demand platform economy is the latest example of a 66.5% increase in alternative work arrangements for U.S. workers from 14.2 million in 2005 to 23.6 million in 2015.7

But while the on-demand platform economy has experienced extraordinary growth since its inception, surprisingly little has been done to understand the tax compliance challenges this new frontier presents, or how the on-demand platform economy impacts Treasury and IRS’ ability to fairly and efficiently administer the U.S. tax code.8 This report, in keeping with the mission of the Kogod Tax Policy Center to conduct non-partisan research on tax and compliance issues for small Introduction businesses and entrepreneurs, targets the tax challenges of the on-demand economy’s small business operators and endeavors to shed light on these issues as Congress looks to move forward with tax reform.

Having spent more than a year investigating this growing problem, we report on what the existing literature has yet to acknowledge: that, for tax purposes, on-demand platform economy service providers and sellers are, in fact, small business owners. And there are millions of them working and earning income in ways that are not readily identifiable by existing government research. In particular, we explore why it’s tough to measure how pervasive the tax problems of these small businesses are because existing government research and methodologies for measuring the smallest of small businesses fall short.

We start by explaining just how pervasive the ondemand platform economy has become for consumers and the labor market, and the tax compliance challenges that go along with trying to adapt a twentieth-century tax code to a twenty-first century economy. We argue that these issues should be addressed—not only because millions of American taxpayers are needlessly burdened trying to comply with an antiquated, outdated tax system—but also because inaction has very real implications on Treasury and IRS’ ability to fairly and efficiently collect taxes.

Our Approach, Data & Methodology

In the course of conducting this research and drafting this report, we reviewed the existing academic and industry literature and surveys on the on-demand platform economy as a first step in approximating just how many millions of U.S. taxpayers are earning income as its small business operators. We compared data sets, research criteria and findings of the latest studies, searching for commonalities to provide insight as to why estimates of the number of U.S. taxpayers earning income as service providers and sellers in the ondemand platform economy vary so widely. We reviewed existing government research (e.g., publicly available taxpayer filing data, U.S. Census Bureau (Census) data, Bureau of Labor Statistics (BLS) data, U.S. Government Accountability Office (GAO) reports, U.S. Department of Treasury (Treasury) technical papers), and identified 2 the limitations in the existing government research with respect to identifying and tracking those small businesses participating in the overall economy.

We then talked to federal government economists at Treasury, the Small Business Administration Office of Advocacy (Advocacy), and GAO as well as other agency officials responsible for studying and writing government research on small businesses, the selfemployed and economic trends as well as taxpayer filing data. We consulted the National Taxpayer Advocate and tax preparer industry experts directly to understand what hurdles and frustrations this group of small businesses face as they navigate their way through tax filing season. We conferenced with on-demand platform company executives, industry experts and academics to solicit their views on both the extent to which U.S. taxpayers are operating in the on-demand platform economy and how those numbers are projected to grow over the next decade.

Finally, we talked to more than 50 individuals currently participating in the on-demand economy and administered our own survey of members of the National Association of the Self-Employed (NASE).

Our survey was designed to gauge existing self-identified self-employed workers’ participation in the on-demand economy (e.g., how many hours worked; how much income earned) as well as respondents’ understanding of their tax filing obligations (e.g., whether respondents kept records for their expenses or received a Form 1099 from their on-demand platform company). We conducted the survey Mar. 10, 2016 through Apr. 1, 2016, through email invitation sent to members by NASE. We received 518 completed responses from the approximately 40,000 NASE members invited to participate in the survey, which constitutes a statistically representative sampling size of NASE members.

Our intention in conducting the survey was not to prepare a statistically reliable estimate of the entire American population of the self-employed or freelancers or all workers in the on-demand platform economy, but rather to assess whether tax compliance challenges exist—even among a group of taxpayers, who, by their own self-selection as members of NASE, are selfemployed small business owners. 9

Ultimately, we concluded that:

  1. More than 2.5 million U.S. taxpayers are participating in the on-demand platform economy as small business owners every year, and millions more are set to join their ranks in the next decade.
  2. For tax purposes, on-demand economy service providers and sellers are small businesses owners, but their numbers aren’t reflected in government data designed to track small business owners. In fact, these taxpayers don’t necessarily realize they are small business owners until tax time or they receive an IRS notice.
  3. At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. Approximately onethird of our on-demand platform operator survey respondents didn’t know whether they were required to pay quarterly-estimated payments and almost half were unaware of any available deductions, expenses or credits they could claim to offset their tax liability. These taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income. Compounding this problem is inconsistent reporting rule adoption that results in widespread confusion among taxpayers.
  4. The current tax administration system isn’t working for a significant percentage of ondemand platform small business operators or Treasury or IRS. More than 60% of our survey respondents who worked for an on-demand platform company in 2015 reported that they did not receive a Form 1099-K or Form 1099- MISC from their on-demand platform, which likely means the IRS didn’t either. The current state of play is one of unnecessary burden, potential audit and penalty exposure for ondemand platform economy players. We can do better.

PART I

Defining the Relationship: Airbnb is not Instagram and Other Measurement Challenges

According to the latest industry statistics, as of January 2016, there were more than 3.97 million apps available for download across several different platforms (e.g., Microsoft, Google, Amazon) that generate more than $120 billion.10 But not every smartphone app functions as part of the on-demand platform economy. Airbnb is not Instagram—they provide completely different services for users. Similarly, not every seller on eBay or Craigslist sells items regularly enough to be considered a business for tax purposes or generates enough income in any given year to trigger a tax filing requirement.

Some online sellers just sell a couple of used items online a couple of times a year, which generally doesn’t trigger a tax filing requirement. At the same time, new on-demand platforms are being introduced every month. This acute reality presents one of the most confounding challenges for conducting tax research on these issues: there is no singular definition or even consensus on how to define or measure the on-demand platform economy or the income that small businesses are deriving from it. As a result, estimates of the number of small businesses operating in the on-demand platform economy are wildly inconsistent.

For example, one recent Time Inc./Aspen Institute survey found that more than 45 million Americans had—at least once—worked or offered services through a ride-sharing, accommodation sharing, task services, short-term car rental or food/goods delivery platform.11 At the same time, other notable experts including Seth Harris and Alan Krueger—excluding seller and home accommodation platforms (e.g., ETSY, Airbnb)—estimate that 1.9 million individuals are earning income as service providers using apps.12

Still other labor survey experts have concluded that there are more than 3.2 million Americans currently working in the on-demand platform economy and project that number to more than double by 2020.13 The explanation for why these estimates range so significantly is rooted in differences in definition. As illustrated in Table 1, including or excluding specific platforms can vary an estimate of the size of the ondemand platform economy and its players considerably.

Given our specific focus on the tax compliance challenges facing these small businesses, we think it makes sense for tax policy purposes to limit our analysis to platforms that generally reflect the following characteristics, which were developed by the first major study to track actual income earned using financial transaction data:

  • platform directly connects service providers and sellers with consumers;
  • platform processes payment electronically, using credit credits, debit cards or mobile payments;
  • platform allows service providers to provide services or goods at provider discretion; and
  • customers pay for a singular task or good.14

There is no question that out of a universe of 3.97 million apps, inevitably, there are some small businesses earning income from the on-demand platform economy that may not be captured by the foregoing criteria, but that would be included in publicly available taxpayer income filing data. However, Treasury has been explicit with Congress in explaining why existing aggregate tax data is “not very helpful in isolating trends in the on-demand economy or in the prevalence of its [workers and sellers].”15 In contrast, recent work using the foregoing criteria on the income of Americans participating in the on-demand platform economy has identified important trends that are particularly relevant to our report’s focus, including:

  • More than 2.5 million Americans are actively participating in the on-demand platform economy every month, which is 1% of the adult American population;
  • Although people do cycle in and out of the ondemand platform economy, during the months in which people are actively using platforms to earn income, their earnings “represented a sizeable but still secondary source of income;”
  • In any given month, on-demand platform income represents roughly 20 to 30% of total income of people actively earning income in the on-demand platform economy; and
  • Average monthly income from active participation ranges from $533 to $314, with the higher amounts usually stemming from working in connection with platforms such as Uber, Handy, TaskRabbit (labor platforms) as opposed to other platforms such as eBay, Airbnb (capitol platforms or sellers and accommodation providers).16

These monthly income averages are consistent with public reports from many of the on-demand platform companies themselves and tend to reflect the averages of hours worked. For example, in 2015, more than 75% of Lyft drivers reported working less than 15 hours per week, and more than half of Uber drivers worked less than 10 hours per week.17 Our survey found that among respondents with income from on-demand economy work in 2015, 72% worked, on average, less than 10 hours a week with their on-demand platform company and that 92% of respondents worked less than 20 hours per week with their on-demand platform company.18 We also found that of respondents operating in the on-demand platform economy, 88% earned less than $15,000 in 2015.19 Although studies to date have identified a core constituency of small business operators (ranging from 25% to 30%) that tend to work for on-demand platforms full-time and earn more, by and large, the majority of individuals in the on-demand platform economy work 12 hours per week.20

Q1

On average, how many hours a week did you spend providing services or selling products using the sharing economy company platform or app?

q1-bar_graph
Answer Choices Responses
0-10 hours per week 50 (72.46%)
10-20 hours per week 14 (20.29%)
20-35 hours per week 2 (2.90%)
More than 35 hours per week 3 (4.35%)

Q2

How much income did you earn in 2015 from your work with the sharing economy platform or app?

q2-bar_graph

Answer Choices Responses
0-10 hours per week 50 (72.46%)
10-20 hours per week 14 (20.29%)
20-35 hours per week 2 (2.90%)
More than 35 hours per week 3 (4.35%)