More and more people are entering the sharing economy at a record pace. According to a survey done by PwC, 19 percent of the total US adult population has now engaged in a sharing economy transaction in some way. Of that growing demographic, many of those engaged as sharing economy workers say that they’ve joined the sharing economy (Airbnb, Uber, Lyft, TaskRabbit, etc.) in an effort to supplement existing income.
Many workers in the sharing economy say that an upcoming vacation, a wedding, or other investments are usually the reasons they will work the extra hours for additional income that may come from Ride or Home Sharing. A study done by Earnest found that 85 percent of side-gig workers average approximately $500 per month which means that they primarily use the income they earn as extra cash and not necessarily as a full-time income.
The study also found that on all of the sharing economy platforms, there is a wide range of earners. Several Airbnb hosts, in their records earned over $10,000 per month, while other hosts earned less than $200 per month.
This trend suggests two things. The first is that the type of worker in the sharing economy is incredibly diverse: sharing economy workers live across the country, they participate in the sharing economy at various levels, and their pre-existing income levels also vary. All these factors vary immensely across the sharing economy. This trend also suggests that sharing economy workers are not doing this exclusively, but rather, typically have other jobs or work that represents the bulk of their time and income.
Our experience at Shared Economy CPA confirms this as many of our clients are full-time professionals or business owners come to us to handle their sharing economy income and expenses. Our clients are already so focused on their pre-existing careers, that going to an expert makes sense.
Most of the feedback we get is, ‘I love doing Airbnb (or insert preferred sharing economy platform here), but I don’t know what the tax implications are or what we should be worried about.’
Inspired by this question, we’ve identified 3 things that all sharing economy workers should know when it comes to taxes.
#1 – Income and Expense – Recording personal versus business records
For most sharing economy workers, expenses related to their side gig activities are usually charged to the same bank account or credit card as their personal expenses. As a result we usually see gross underestimation of the full list of business expenses. A very important step to take here is to identify a full list of things you buy and pay for that benefit the sharing economy business. Even if only a fraction of the good or service benefits the business, the portion attributable to the business can be deducted. Overstating income by not capturing your full list of deductions may subject you to underpayment penalties if you owe over $1,000 in taxes. According to the Wall Street Journal, last year the IRS saw a 40% increase in underpayment penalties, which is partially attributable to sharing economy workers.
According to IRS Publication 535, the IRS issues specific guidelines on how to split a business expense versus a personal expense.
For example, for the business use of your home, the following allocation methods are suggested:
The two methods of allocating business use of your home are based on square footage or the number of rooms.
The first method uses the number of rooms used for business divided by the total number of rooms in your home. The second method takes the square footage of the space that you use for business, divided by the total square footage of the house.
In order to calculate the deduction, some taxpayers opt to use the simplified option offered by the IRS. Under this simplified option, the standard home office deduction is $5 per square foot up to 300 square feet of the area that you have used regularly and exclusively for business. The maximum deduction is $1,500 and you just have to follow the instructions for line 30 of Schedule C in order to determine your deduction.
If you instead prefer to use the regular method, Form 8829, Expenses for Business Use of Your Home will assist you in calculating the deduction.The regular method uses the actual expenses determined and the records maintained for your business in order to calculate the deduction.
The tax laws allow you to use whichever method will result in a larger deduction. As a result, you should make sure to calculate your deduction using both the simplified option and the regular method. Keep in mind that the goal is to reduce your tax liability. Therefore, the simplified option might not be the best one since it’s capped.
Given the complexity of determining your allowed deductions, having a process to record and manage all the business’ expenses is incredibly important for accurately projecting and estimating your net profit from the business. The net profit from your business also determines taxes owed and whether you need to pay quarterly taxes. If you don’t you can get hit with an underpayment penalty when you file your tax return. A great way to segment these expenses is to have a separate bank account for your sharing economy work. Otherwise, we recommend getting software with features that allow you to assign “personal” and “business” categories to your transactions. We recommend free accounting software tools such as Wave Accounting or QuickBooks Self Employed, which can charge between $10 and $25 per month. (Be sure to ask us for a discount code if you are interested in QuickBooks Self Employed.)
In addition, being able to demonstrate a methodology for splitting business versus personal expenses is exceptional way to show auditors you’re not guessing when it comes to figuring out your tax bill. For those reading this who are a client, you’ll know that we have an audit-tested method for splitting and documenting expenses.
#2 – Paying Quarterly Taxes – Knowing when and if you need to pay taxes throughout the year
Depending on certain rules, you may be required to pay estimated taxes or face a penalty. This penalty is essentially an interest charge for not paying taxes throughout the year. To determine whether you will need to pay taxes, you will need to calculate your net profit throughout the year.
For the 2016 tax year, the interest rate for underpayments by individual taxpayers is 4 percent. The IRS sets this rate quarterly. This rate applies for the following periods — April 16 through June 30, July 1 through September 30, October 1 through December 31, and January 1, 2017 through April 15, 2017.
In general, you may owe a penalty for the prior year (2017) if the total of your withholding and estimated tax payments were less than:
- 90% of your current (2017) tax (calculated when you file in 2018), or
- 100% of your prior year tax (2016)
Total tax in prior years is generally the amount on your prior year Form 1040, Line 63.
The exception to the rule above applies to taxpayers who owe less than $1,000 in tax or if you had no tax liability last year.
To determine your tax and taxable income, you’ll need to have a very clear picture of the profit and loss statement (See step 1).
#3 – Tax Structure – Figuring out whether an LLC, S Corporation, or another business entity works best
Lastly for the purposes of this post, we consider the entity. One of the most important decisions to make is on your entity structure. While we like the benefits of an LLC because of the personal liability protection and its relatively low cost setup, an S Corporation can provide maximal tax savings given a certain set of facts (generally when the entity reaches $30,000 in net profit). In cases where an LLC has only one member, tax treatment will remain the same and compliance is relatively simple. Legal entities are also less frequently audited than Sole Proprietorships, so from that standpoint alone we’d recommend considering incorporation.
Due to the various considerations around entity setup, we suggest considering your business goals, legal needs, and tax factors before making a decision. Often, entity selection depends on personal preferences and aversion to risk, so we advise having a conversation with your tax professional and attorney before coming to a conclusion.
Costs associated with entity setup in our experience can range from the low hundreds on a do-it-yourself platform (such as LegalZoom) to the low thousands (for example, with a regional law firm). Fees can vary depending on complexity, firm size, and region.
For more information on incorporation, check out our previous blog posts, Should I Incorporate My Rideshare Business and Should I Incorporate my Airbnb Business.