Financial Planning for the Gig Economy

Financial Planning for the Gig Economy

The gig economy is a sector of the workforce in which people do not have long-term employment. Those in the gig economy are contingent workers—freelancers, consultants, tradespeople—who cannot necessarily count on their next gig. They may obtain assignments or projects through companies such as Uber, Lyft, TaskRabbit, or Upwork, or they may engage directly with companies or individuals needing their talents.

These individuals face important financial and tax challenges. This article focuses on gig economy workers who are independent contractors (note that not all gig workers are self-employed) and addresses the issues that are key to them. Of course, some employees may moonlight in the gig economy, but they do not have the same concerns as those who work exclusively in this sector.

Savings and Budgeting
Because income from freelancing, consulting, or other contingent work is not necessarily steady, it is vital for a gig worker to be proactive in managing money. This includes establishing a savings program to create a financial cushion when things are slow. It also requires careful budgeting so that funds are not frivolously spent when they come in, but are instead applied for various necessary purposes (e.g., estimated taxes, retirement savings, a rainy day fund).

Health Coverage
One of the prime concerns of most workers today is health coverage. Many employers offer this benefit, but those who work exclusively in the gig economy must find coverage themselves. We recommend working with a qualified agent to avoid mistakes and coverage gaps. This can be done in several ways:

  • Buying individual (or family) coverage
  • Using COBRA
  • Tax deduction

Disability Coverage

For a self-employed individual, becoming injured and unable to work can present a significant financial problem. Regular employees who are injured on the job have workers’ compensation protection; they may also enjoy long-term disability coverage through their employer.

Retirement Savings
Employees may be able to participate in company-sponsored retirement plans, but gig workers must save for their own retirement. They must determine which type of retirement plan is best for them and be sure to fund it annually. Options include the following:

  • 401(k) plans
  • Simplified employee pensions (SEP)
  • Individual retirement accounts (IRA)
  • Roth IRAs

Finding the money to put into a retirement plan can be difficult for some. The point to remember is that contributions (other than for Roth IRAs) are tax deductible; thus, in effect, the government is contributing a portion of the funding. For a gig worker in the 22% tax bracket, the tax savings from a $10,000 contribution to a SEP is $2,200 (i.e., the government’s contribution).

Paying Taxes
Gig workers must report their income and pay taxes on it; this includes both income tax and self-employment tax to cover Social Security and Medicare taxes. Unfortunately, many gig workers who previously were used to being W-2 employees with wage withholding are unfamiliar with their tax responsibilities.

Reporting income
All income earned must be reported on Schedule C (or C-EZ). Gig workers may receive information returns (Form 1099-MISC or Form 1099-K) listing certain earnings; whether or not an information return is received, the income should be reported. For example, a person may receive $500 for a project that is not reported on Form 1099-MISC because it is below the $600 threshold at which the form is required, but the payment is still reportable income.

Paying self-employment tax
Gig workers are also subject to self-employment tax, which comprises Social Security and Medicare taxes. As self-employed individuals, they pay both the employer and employee share of these taxes, with a one-half deductible as an adjustment to gross income.

Paying the additional Medicare tax
Income from gigs is potentially subject to the 0.9% Medicare tax. It is not part of the self-employment tax, and it is not deductible. It should be factored into estimated taxes (discussed below).

Making estimated tax payments
Because there is no withholding, gig workers usually have to satisfy their tax obligations through the payment of estimated taxes, which may be unfamiliar to many gig workers. Estimated payments are made to cover federal tax obligations four times per year.

Special tax breaks
The gig worker may be entitled to special tax breaks:

Home office deduction. If the home is the principal place of business, or there is no other fixed location for the person and space in the home is used to do administrative work (e.g., keep books and records, do research, schedule appointments), then the worker may be eligible for a home office deduction. The space must be used regularly and exclusively for this purpose. Some individuals are reluctant to take a home office deduction for fear that it is an audit red flag, but there are no statistics supporting this belief, and the IRS encourages eligible taxpayers to take the write-off.
Qualified business income deduction. Starting in 2018, there is a potential 20% deduction from taxable income based on business income. While several limitations apply, anyone with taxable income below $207,500 ($415,000 on a joint return) likely can benefit from this new deduction.

One of the potential problems facing some gig workers is the hobby loss rule (Internal Revenue Code section 183). This is triggered when expenses from an activity exceed the income from the activity, and the rule requires all income to be reported but only allows a deduction for expenses to the extent of income. Gig workers must be prepared to show that they’re engaging in an activity with a reasonable intention of making a profit, and not for personal pleasure or recreation.

Rising to the Task
Providing guidance to individuals who are working in the gig economy is an important service. CPAs and other financial advisors should be sure to take a holistic approach to help these individuals address all of their financial and tax concerns.

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