A Tax Loophole You Could Drive an Uber Through

By Samuel Handwerger

SMITH BRAIN TRUST – There are two certainties, the old saying goes: Death and taxes.

And though there are no known loopholes for death, tax professionals like myself discover new tax loopholes from time to time. The one I discovered last week while offering some filing assistance as part of the Volunteer Income Tax Assistance (VITA) program at the University of Maryland’s Robert H. Smith School of Business involves independent contractors. Uber drivers, to be precise.

This loophole, if not closed, could shortchange the government of some tax revenue it’s rightly owed and could turn some Uber drivers into tax cheats, some of them unwittingly.

Here’s what happened.

Two Uber drivers came to VITA earlier this month, looking for help with their tax returns. For one driver, only a portion of the year’s earnings was reported on the 1099 forms from the ride-hailing company. A substantial amount appeared to be missing.

The rest – a significant portion of compensation – was coming directly from the credit card payments which Uber processed on behalf of the drivers. These so-called “third-party payment processors” have different reporting requirements than your typical independent contractor arrangement.

Let’s simplify.

First, you have people who are classified as “employees.” The reporting of their income to the IRS is fairly familiar to us these days. In those cases a W-2 is prepared by the employer, even if the amount of compensation is just $1 in a single calendar year (a little ludicrous, but “them’s” the rules) with appropriate income taxes withheld based on level of income.

Next come independent contractors. Here the payer doesn't withhold taxes and only reports if the income paid to the independent contractor for the year exceeds $600 and is reported on Form 1099-MISC. To boot, there are no taxes withheld. This creates a headache for the IRS since – can you believe it? – some independent contractors have a hard time filing their tax return and paying the tax due. Without the withholding of tax, the IRS is often left to being little more than a frustrated collection agency.

Finally, we now see the advent of a fairly new terminology, the “third-party payment processor,” found more often in the on-demand workforce. Here companies like Uber and Lyft take the position that they are just processing credit card payments for the drivers as the contract is between the customer and driver, not  between the company and the driver. Lyft, for example, will report these payments processed on behalf of the drivers under rules of reporting third-party payments using Form 1099-K.

As with the Form 1099-MISC, these 1099-K processed payments do not have taxes withheld. However, unlike Form 1099-MISC, which is required for payments over $600, the 1099-K is only required for third-party payers where the recipient receives over $20,000 AND has more than 200 transactions in a calendar year. The “and” is the key here, because both requirements are necessary. Example: A driver with $30,000 in payments representing 199 trips does not have to receive a 1099-K.

When Uber first started reporting payments to its drivers under the third-party processing viewpoint in 2014, they issued 1099-K’s to all drivers, regardless of level of sales or transactions. Not so with Lyft, which played strictly by the book, only reporting drivers who were compensated at least $20,000 in total, over at least 200 transactions. Uber eventually changed in reporting policy in 2017. It now reports compensation only for drivers that reach the threshold. (I will feign naivety on why they made the change, but you can see where I am going with this.)

Back to our client at the school’s VITA tax clinic. This particular individual was being faithful to his country and the tax code by diligently reporting all his income, even though not reported, which is – can you believe it? – the law. But what about Uber drivers who just don’t keep good records? And what about the drivers who drive for both Lyft and Uber? These payments are not aggregated to get to the 1099-K reporting threshold; each payment processor stands on its own in terms of reporting requirements. Could this be an additional factor motivating drivers to take on both assignments?

So, where does this leave us? With the distinct possibility that there could be underreporting of income among Uber drivers, Lyft drivers and other workers in the gig economy. And yes, this is not a legal tax loophole.

A seemingly ideal and equitable solution would be to have taxes withheld on even independent contractors, reducing distinction between employees and independent contractors.

Fat chance, you might be thinking, because of the burden it might place on businesses.

In 1977, the IRS was put on hold from regulating this employee versus independent contractor issue, with a statute promising that Congress would draft a law. It’s been 40 years, and it’s still an unfulfilled promise.

Meanwhile companies, such as Uber, continue to pay workers as independent contractors. And many of them could soon find out that they owe more taxes than they bargained for. That may be a whole other story for another day.

For now, at VITA, we are on the lookout for these missing 1099-K instances so we can advise clients of their duty to report all their income, even when a 1099 is not received.

Samuel Handwerger is a lecturer in the Accounting & Information Assurance Department at the University of Maryland's Robert H. Smith School of Business.