A Job, A Gig and Work Expenses

 

The case is straightforward enough, but it reminded me how variations of the story repeat in practice.

Take someone who has a W-2, preferably a sizeable W-2.

Take a gig (that is, self-employment activity).

Assign every expense you can think of to that gig and use the resulting loss to offset the W-2.

Our story this time involves a senior database engineer with PIMCO. In 2015 he reported approximately $176,000 in salary and $10,000 in self-employment gig income.  He reported the following expenses against the gig income:

·      Auto      $14,079

·      Other     $12,000

·      Office    $ 7,043

·      Travel    $ 6,550

·      Meals     $ 3,770

There were other expenses, but you get the idea. There were enough that the gig resulted in a $40 thousand loss.

I have two immediate reactions:

(1)  What expense comes in at a smooth $12,000?

(2)  Whatever the gig is, stop it! This thing is a loser.

In case you were curious, yes, the IRS is looking for this fact pattern: a sizeable (enough) W-2 and a sizeable (enough) gig loss.

In general, what one is trying to do is assign every possible expense to the gig. Say that one is financial analyst. There may be dues, education, subscriptions, licenses, travel and whatnot associated with the W-2 job. It would not be an issue if the employer paid or reimbursed for the expenses, but let’s say the employer does not. It would be tempting to gig as an analyst, bring in a few thousand dollars and deduct everything against the gig income.

It’s not correct, however. Let’s say that the analyst has a $95K W-2 and gigs in the same field for $5k. I see deducting 5% of his/her expenses against the gig income; there is next-to-no argument for deducting 100% of them.

The IRS flagged our protagonist, and the matter went to Court.

We quickly learned that the $10 grand of gig income came from his employer.

COMMENT: Not good. One cannot be an employee and an independent contractor with the same company at the same time. It might work if one started as a contractor and then got hired on, but the two should not exist simultaneously.

Then we learn that his schedule of expenses does not seem to correlate to much of anything: a calendar, a bank account, the new season release of Stranger Things.

The Court tells us that his “Travel” is mostly his commute to his W-2 job with PIMCO.

You cannot (with very limited exception) deduct a commute.

There were some “Professional Fees” that were legit.

But the Court bounced everything else.

I would say he got off well enough, all things considered. Please remember that you are signing that tax return to “the best of (your) knowledge and belief.”    

Our case this time was Pilyavsky v Commissioner.

Changes to 2020 Federal Payroll Taxes

There were two bills passed in March that significantly impacted payroll taxes for 2020. The first – Families First Coronavirus Response Act – expanded employee paid leave, with the intent that the cost of the leave be shifted to the government via refundable payroll tax credits. The second – The Coronavirus Aid, Relief and Economic Security Act - allows employers to defer the deposit of (some) payroll taxes, while also providing a payroll tax credit to encourage employers directly affected by the virus (either through government order or decline in business) to retain employees.

Following is a recap to aid as you work through this new minefield. As always, remember that no recap is exhaustive. Please be advised to review the underlying guidance for specific issues and questions.

The President signed the CARES Act on March 27, 2020.

The CARES act brought us the Employee Retention Credit (ERC).

(1)  Eligible employers include tax-exempt organizations but not government agencies.

(2)  Eligible employers have a refundable credit equal to 50% of qualified wages (including allocable health care expenses) paid employees if the employer …

(a)  Fully or partially suspends operations during 2020 due to orders from an appropriate governmental authority due to COVID-19; or

(b)  Experiences a significant decline in gross receipts during a calendar quarter.

a.    The period begins with the first quarter in which gross 2020 receipts are less than 50% of gross receipts for the same quarter in 2019.

b.    The period ends the quarter after the quarter whose gross receipts exceed 80% for the same quarter in 2019.

(3)  Qualified wages mean wages paid after March 12, 2020 and before January 1, 2021.

NOTE: This means that an eligible employer may claim the credit for qualified wages paid as early as March 13, 2020.

(4) Qualified wages include allocable health care expenses and are limited to $10,000 per employee for 2020.

(5) Qualified wages vary significantly depending on the size of the employer.

(a)   If the employer had 100 or fewer full-time equivalents (FTEs) in 2019, then qualified wages include wages paid all employees.

(b)  If the employer had more than 100 FTEs in 2019, then qualified wages mean wages paid an employee not working because of (a) government orders or (b) a significant decline in gross receipts.

(6) The credit is 50% of qualified wages, meaning the maximum credit is $5,000 ($10,000 times 50%).

(7) Technically, the credit is allowed only against the employer share of social security tax (that is 6.2%), but this is misleading. The credit is fully refundable, so it will continue offsetting employee payroll withholdings and employer payroll taxes until the credit exhausted. If there is still a credit remaining, then the remaining credit is refundable to the employer.

EXAMPLE: CTG Command Center pays $10,000 in qualifying wages in quarter 2, 2020. Employee federal income tax, social security and Medicare withholdings are $4,000. The employer social security is $620 ($10,000 times 6.2%), for a required total payroll tax deposit of $4,620. The retention credit is $5,000. The retention credit will offset all the required payroll tax deposits – employee and employer – and result in a $380 refund to CTG Command Center.

(8) The IRS realized that having an employer make payroll tax deposits, only to have those deposits later refunded, is not prudent cash flow management. The IRS will therefore allow an employer to offset otherwise required payroll tax deposits by anticipated payroll tax credits. The amounts otherwise due or credited are to be accounted for with the filing of the quarterly Form 941. If payroll tax credits are expected to exceed payroll tax deposits otherwise required, there is also a procedure to obtain an advance refund (that is, before filing Form 941) from the IRS.

(9) There is an unusual interaction with the CARES deferral of employer payroll taxes:

·      An employer can defer and still receive the employee retention credit, resulting in, in effect, an interest-free loan from the government.

(10) There is no equivalent of the retention credit for self-employeds.

(11) This credit does not play well with the emergency sick or expanded family leave provisions. In short, one cannot use the same wages for more than one credit.

(12) This credit is not available if the employer receives a Paycheck Protection loan.

 The CARES Act also brought us the deferral of employer social security taxes.

(1) An employer’s payroll tax liability has two parts: social security tax at 6.2% and Medicare tax at 1.45%. The deferral is solely for the employer share of social security taxes (that is, 6.2%).

(2) Unlike the ERC, the deferral applies to deposits (rather than wages paid) otherwise required beginning March 27, 2020 and through December 31, 2020.

COMMENT:  Therefore, payroll taxes accrued before March 27, 2020 would qualify as long as the payroll tax deposit was due on or after March 27, 2020.

(3) All employers are eligible. Unlike the ERC, there is no employer size limitations.

(4) Unlike the ERC, there is no requirement that the employer be affected by COVID-19.

(5) The deferral is as follows:

(a)  50% of taxes deferred are due December 31, 2021

(b)  The remaining 50% is due December 31, 2022

(6) The deferral also applies to self-employeds. The amount deferred is 6.2% of the total 15.3% self-employment tax rate. The is no deferral once the self-employed exceeds the maximum social security wage base.

(7) There is an unusual interaction with the Families First emergency sick and expanded family leave credits.

·      An employer can defer and still receive the emergency sick and expanded family leave credits, resulting in, in effect, an interest-free loan from the government.

(8) There is an unusual interaction with the employee retention credit (ERC).

·      An employer can defer and still receive the employee retention credit, resulting in, in effect, an interest-free loan from the government.

(9) There is an unusual interaction with a Paycheck Protection loan.

·      No further deferrals are allowed after an employer receives notice of Paycheck Protection Loan forgiveness.

·      However, deferrals up to that date remain eligible for deferral and are due December 31, 2021 and 2022.

(10) Note that the deferral affects payroll taxes due on or after March 27, 2020, meaning that one would expect the deferral to be accounted for on the first quarter employer Form 941.

The IRS has clarified that the credit for this stub period will NOT be accounted for on the first quarter Form 941. Rather they will be added to any credits arising during the quarter two and reported on the second quarter Form 941.

The President signed the Families First Coronavirus Response Act on March 18, 2020, introducing two new (and temporary) paid-leave benefits.

Emergency Sick Leave

(1)  Applies to businesses and tax-exempt organizations with fewer than 500 employees 

(2)  Applies immediately to employees of the above employers

(3)  The tax credit is based on qualifying leave provided employees between April 1, 2020 and December 31, 2020.

·      Note that emergency sick leave wages paid in 2021 will qualify if paid for leave taken between April 1 and December 31,2020. 

(4)  Full-time employees can receive up to 80 hours of sick leave. Part-time employees can receive leave based on the average number of hours worked over a two-week period of time.  

(5)  If …

a.     The employee is subject to a federal, state or local quarantine or isolation order related to COVID-19;

b.    The employee has been directed by a healthcare provider to self-quarantine due to concerns related to COVID-19;

c.     The employee is seeking to obtain medical diagnosis when experiencing symptoms of COVID-19

… then the maximum (creditable) paid leave is the employee’s regular rate of pay, up to $511 per day and limited to $5,110 per employee.

(6)  If the employee takes time-off …

a.     To care for a family member who is subject to a federal, state or local quarantine or isolation order related to COVID-19;

b.    To care for a child (under 18 years of age) whose school has been closed or paid childcare provider is unavailable due to COVID-19; or

c.     Because the employee is experiencing any other substantially similar conditions as specified by the Secretary of Health and Human Services

… then the maximum (creditable) paid leave is 2/3 of the employee’s regular rate of pay, up to $200 per day and limited to $2,000 per employee.

(7)  For both (5) and (6), the employer is allowed to increase the credit amount by the allocable cost of the employee’s health insurance coverage.

(8)  Employers are still required to withhold employee federal income taxes and the employee’s share of Social Security and Medicare taxes. 

·      The intent is that this will be covered by the $511/$200 per day allowance.

(9)  Wages paid under the emergency sick leave provision ….

a.     Are NOT be subject to employer social security (6.2%), and

b.    ARE subject to employer Medicare (1.45%)

                                                      i.     However, this employer Medicare requirement is misleading because the credit will be increased by the amount of

1.    The employer Medicare tax, and

2.    The allocable cost of health insurance coverage

EXAMPLE: CTG Command Center pays one employee $200 per day for 10 days. It also pays $100 in health care costs. Employee withholdings are $300 for federal income tax, $124 for social security and $29 for Medicare – a total of $453.Net pay is therefore $1,547 ($2,000 – $453) and total compensation (including health care and employer Medicare) is $2,129. CTG Command Center will receive credit on its payroll tax return for $2,000 + $100 (allocable health care) + $29 (employer Medicare) = $2,129. This means that the cost of the employee (excluding unemployment insurance and workers compensation) has been shifted from CTG Command to the federal government for the covered period.  

(10)        The credit can be offset against all employee withholdings and employer payroll taxes.

·      Any excess is refundable to the employer.

(11)       Any credits utilized will constitute taxable income to the employer.

·      Offsetting the employer payroll tax expense on wages paid emergency leave employees.

(12)       There is a comparable provision for self-employeds

a.     However, the “average daily self-employment income” will not be calculable until year-end, as it refers to 2020 net earnings from self-employment divided by 260 days.

EXAMPLE. Rocket Man is self-employed. He earned $185,000 for 2020, and he spent 10 days taking care of his mom during the crisis. His daily self-employment income is $712 ($185,000 divided by 260). That however exceeds $200, so his allowable paid sick leave is $2,000. His 2020 net earnings from self-employment are reduced by $2,000. He is also allowed to reduce his otherwise-required quarterly estimated tax payments accordingly. 

(13)       There is an unusual interaction with the emergency sick leave credit and the employer payroll tax deferral.

·      An employer can defer and still receive the emergency sick leave credit, resulting, in effect, an interest-free loan from the government.

(14) This credit does not play well with the employee retention credit. In short, one cannot use the same wages for more than one credit.

Expanded Family Leave

(1)  Applies to businesses and tax-exempt organizations with fewer than 500 employees 

(2)  This is a narrow expansion of FMLA to include

… employees unable to perform services (including telework) because of need to care for a child whose school or place of care is closed or whose childcare provider is unavailable due to COVID-19. 

(3)  The employee must have worked for the employer for at least 30 day to qualify.

(4)  The credit is based on qualifying leave provided employees between April 1, 2020 and December 31, 2020

·      Note that emergency sick leave wages paid in 2021 will qualify if paid for leave taken between April 1 and December 31,2020. 

(5)  The provision allows up to 12 weeks of employer-provided protected leave, 10 of which is creditable to the employer.

(6) The maximum (creditable) emergency family leave is the employee’s regular rate of pay, up to $200 per day and limited to $10,000 per employee.

(7) The employer is allowed to increase the credit amount by the allocable cost of the employee’s health insurance coverage.

(8)  Employers are still required to withhold employee federal income taxes and the employee’s share of Social Security and Medicare taxes.

·      The intention is that this will be covered by the $200 per day allowance.

(9)  Wages paid under the expanded family leave provision ….

a.     Are NOT be subject to employer social security (6.2%), and

b.    ARE subject to employer Medicare (1.45%)

                                                      i.     However, this employer Medicare requirement is misleading because the credit will be increased by the amount of

1.    The employer Medicare tax, and

2.    The allocable cost of health insurance coverage

(10)       The credit can be offset against all employee withholdings and employer payroll taxes.

·      Any excess is refundable to the employer.

(11)       Any credits utilized will constitute taxable income to the employer.

·      Offsetting the employer payroll tax expense on wages paid emergency leave employees.

(12)       The example given above for emergency sick leave also covers expanded family leave.

(13)       The discussion about self-employeds given above also covers expanded family leave.

(14)       There is an unusual interaction with the expanded family leave credit and the employer payroll tax deferral.

·      An employer can defer and still receive the expanded family leave credit, resulting in, in effect, an interest-free loan from the government.

(15)       This credit does not play well with the employee retention credit. In short, one cannot use the same wages for more than one credit.

(16)       The FMLA “restoration to position” provision under FMLA does not apply to employers with fewer than 25 employees and meeting certain other requirements.

The Gig Economy

Say that I retire. Perhaps my wife wins the lottery or marries well.

I get bored. Perhaps I would like a little running-around money. Maybe I flat-out need extra money.

I find a website that connects experienced tax practitioners to people needing tax services. There might be specializations available: as a practitioner I might accept corporate or passthrough work, for example, but not individual tax returns. I could work as much or as little as I want. I might work Friday and Saturday afternoons, for example, but not accept work on weekdays. I could turn down or fire clients. I could take time off without fear of dismissal.

There would have to be rules, of course. Life is a collection of rules. I might have to provide my state license to substantiate my credentials. I might have to post an E&O policy. It seems reasonable to expect the website to impose standards, such as for professional conduct, client communications, timeliness of service and so on

How would I get paid?

I am thinking that I would bill through the website. An advantage is that the website can devote more resources than I care to provide, making the arrangement a win-win-win for all parties involved. The website would collect from the client and then electronically deposit to my bank account.

Here is my question: is the website my employer?

Don’t scoff. We are talking the gig economy.

The issue has gained notoriety as states – New Jersey and California come to mind – have gone after companies like Uber and Lyft. From these states’ perspective, the issue is simple: if there is more than a de minimis interdependence between the service recipient and provider, then there must be an employment relationship between the two. Employment of course means FICA withholding, income tax withholding, unemployment insurance, disability insurance (in some cases), workers compensation and so on.

Let us be honest: employment status is Christmas day for some states. They would deem your garden statue an employee if they could wring a dollar out of you by doing so.

New Jersey recently hit Uber with a tax bill for $650 million, for example.

The employee-independent contractor issue is a BIG deal.

What in the world is the difference between an employee and an independent contractor?

People have been working on this question for a long time. The IRS has posited that employment means control – of the employer over the employee – and also that control travels on a spectrum. As one moves to the one end of the spectrum, it becomes increasingly likely that an employer-employee relationship exists.

The IRS looks at three broad categories:

(1)  Behavioral control

(2)  Financial control

(3)  Relationship of the parties

The IRS then looks at factors (sometimes called the 20 factors) through the lens of the above categories.

·        Can the service recipient tell you what, where, when and how to do something?

·        Is the service recipient the only recipient of the provider’s services?

·        Is the service relationship continuing?

Answer yes to those three factors and you sound a lot like an employee.

Problem is the easy issues exist only in a classroom or at seminar. In the real world, it is much more likely that you will find a mix of yes and no. In that event, how may “yes” answers will mean employee status? How many “no” answers will indicate contractor status?

Answer: no one knows.

Some states have taken a different approach, using what is called an “ABC” test. There was a significant case (Dynamex) in California. It interpreted the ABC test as follows:

(1)  The service provider is free from the direction and control of the service recipient in connection with the performance of the work.

(2)  The service provider performs work outside the usual course of the service recipient’s business.

(3)  The service provider is customarily engaged in the independent performance of the services provided.

I get the first one, but I point out that it is rarely all or nothing. If we here at CTG Command bring on a contractor CPA – say for the busy season or to collaborate on a tax area near the periphery of our experience – we would still have expectations. For example,

·        our office hours are XXX

·        reviewer turnaround times to tax preparers are XXX

·        responses to client calls are to occur with XXX hours or less

·        responses to me are to occur within X hours or less

·        drop-dead due dates are XXX

How many of these can we have before we fail the A in the ABC test?

Let’s look at B.

We are a CPA firm. Odds are we are interested in experienced CPAs. It is quite unlikely that we will have need of a master plumber or stonemason.

Have we automatically failed the B in the ABC test?

And what does C even mean?

I am a 30+ year tax CPA. I am a specialist and have been for many years. I would say that I am “customarily engaged” in tax practice. Do I have “independent performance,” however?

If I interpret this test to mean that I have more than one client, it somewhat makes sense, although there are still issues. For example, upon semi-retirement, I would like to be “of counsel” to a CPA firm. I have no intention of working every day, or of being there endless hours during the busy season. No, what I am thinking is that the firm would call me for specialized work – more complex tax issues, perhaps some tax representation. It would provide a mental challenge but not become a burden to me.

Would I do this for more than one firm?

Doubt it. I point to that “burden” thing.

Have I failed the C test?

I am still thinking through the issues involved in this area.

Including non-tax issues.

If I take an Uber and the driver gets into an accident – injuring me – do I have legal recourse to Uber? Seems to me that I should. Is this question affected by the employee-contractor issue? If it is, should it be?

This prompts me to think that the law is inadequate for a gig economy.

There is, for example, always some degree of control between the parties, if for no other reason than expectation is a variant of control. Not wanting to lose the gig is – at least to me – an incident of control to the service recipient. Talk to a CPA firm partner with an outsized client about expectation and control.

Why cannot CTG Command gig an experienced tax professional – say for a specific engagement or issue - without the presumption that we hired an employee? I can reasonably assure you that I will not be an employee when I go “of counsel.” You can forget my attending those Monday morning staff meetings.

Am I “independently performing” if I have but one client? What if it is a really good client? What if I don’t want a second client?

Problem is, we know there are toxic players out there who will abuse any wiggle room you give them. Still, that is no excuse for bad tax law. Not every person who works – let’s face it – is an employee. The gig economy has simply amplified that fact.