Most freelancers are unfamiliar with the process of paying taxes and don’t realize it's a pay-as-you-go system: Tax Professor

Caroline Bruckner, Kogod School at American University joins the Yahoo Finance Live panel to discuss the biggest challenges that gig economy workers will face this tax season.

Video Transcript

ZACK GUZMAN: Welcome back to Yahoo Finance Live. And this week's tax time, we're breaking down some big questions that our viewers have regarding the upcoming tax season, given all the changes on the stimulus front on the freelancing front, as well, as we see more Americans start to work as freelancers.

I want to bring on our next guest to break down all the questions and answers. Joining us right now on that front, Caroline Bruckner, a tax professor, the faculty of American University Kogod School of Business and managing director of the Kogod Tax Policy Center joins us right now.

And Caroline, I guess, you know, some Americans out there might be facing this question of what it means to pay taxes, a freelancer for the first time. So what stands out as important to know this time around?

CAROLINE BRUCKNER: So a couple of things are really important. For freelancers, most of them are unfamiliar with the process of paying taxes. And so they don't realize it's a pay-as-you-go system. So we pay a little bit out of every paycheck. When we're employees, our employers withhold and send that money on to the IRS. When you're a freelancer, you don't get the benefit of withholding.

And if you are going to owe more than $1,000 in taxes over the course of a year, you should have been paying quarterly estimated payments. That is a huge tripping point for many freelancers the first year they file.

A second issue that really comes up and really hurts gig workers is they don't know that they're responsible for paying self-employment tax. These are the equivalent of payroll taxes. So your social security and Medicare taxes, it's 15.3% on their net earnings of over $400 or more.

That really can be a bare for gig workers who might not even owe any income tax on their earnings, particularly if they're low wage or low-income taxpayers. But they still, nevertheless, have to file a return to pay self-employment tax, which is a separate schedule with our 1040.

AKIKO FUJITA: One of the reasons you're focused on gig workers is, of course, because we've seen so much growth during the pandemic even those who had jobs who were potentially looking for additional funds on the side. When you look at the pool as a whole, how much of an increase have we seen during the last fiscal year?

CAROLINE BRUCKNER: So MBO Partners, which tracks independent contract work every year, just put out their latest survey results in December of 2020. And they found that across the board, only occasional gig workers. So folks that have a side hustle were the only category of workers that actually had job growth, not just job recovery.

And that number increased from 15 million in 2019 up to 15.8 million. So about 800,000 people. And that makes sense, because when people were furloughed or they lost their full-time job, what did they do? They turned to their side hustle to make up the difference in income.

ZACK GUZMAN: The other thing that we were talking about in last week's tax time is kind of the question and maybe surprise around having to pay taxes on unemployment insurance and that whole aspect of the tax season. But, I mean, when you look at what Americans are, I guess, bracing for this time around, it doesn't necessarily sound fun to have to pay as you go where some people have the enjoyment of just that withholding up front. I guess what's the biggest headache for Americans that you work without there in dealing with all this, especially in a pandemic?

CAROLINE BRUCKNER: So there are a couple of really big challenges. The first one is, yes, unemployment insurance is in fact taxable income. And this matters for gig workers because part of the CARES Act, what it did was create unemployment insurance availability for gig workers and self-employed workers who traditionally are shut out from claiming unemployment insurance under state programs.

So when Congress made that change, gig workers for the first time, so existing gig workers, could claim unemployment insurance. And the reality is that most state agencies did not do withholding in as part of the pay-as-you-go system for federal tax liability.

What that means is that a lot of gig workers are going to go file their taxes having claimed unemployment insurance because they didn't have work and then walk away actually owing a tax bill, problem number one. Problem number two, how do you pay your taxes when you don't actually even get an information return from the company you work with?

Under current tax reporting rules, online platforms aren't required to give gig workers that they work with. So Uber drivers, Lyft drivers, Airbnb hosts-- they don't get any kind of tax form-- tax reporting form like a 1099 from the platforms they work with until they have $20,000 in transactions and 200 transactions. So very few gig workers make that $20,000, 200 transaction threshold to even get a 1099. So they don't even have records on how much income that they earned.

ZACK GUZMAN: Yeah, just more headaches on top of those headaches for people who are not exactly as established in the freelancing space. But Carolyn Bruckner from the Kogod Tax Policy Center-- appreciate you joining us to answer all those questions for us. Have a great weekend as well.