Hiring a Freelancer? Here’s What That Means for Your Taxes

The gig economy has seen tremendous growth over the past decade. And with the rise in remote work during the pandemic, a shift in how businesses think about their employees and hiring practices, and the growing number of people pursuing business ventures online, it will likely keep growing.

In many ways, this trend was born out of necessity during the Great Recession. In 2008, 2.6 million people found themselves out of work due to mass layoffs and furloughs. They began to look for alternatives to the regular 9-to-5 workday to make ends meet.

As a result, the economic downturn gave rise to some of the largest companies in the world today: Uber, Airbnb, and TaskRabbit, to name a few. Some selling platforms that existed before 2008, like eBay and Etsy, were attractive options for people looking to make extra cash. They’ve since become major players in the online retail space.

What gig economy taxes mean for businesses

Suppose your business is looking to take advantage of the benefits of working with freelancers. In that case, it’s important to understand the ins and outs of the gig economy — especially when it comes to freelance work and taxes.

One of the most important things to consider is whether you’re working with an employee or an independent contractor. This designation radically changes your company’s responsibilities. New standards from the U.S. Department of Labor include several guidelines to determine those responsibilities, including an economic reality test that clarifies whether a freelance worker is economically dependent on an employer or working as an independent business.

Included in that test are two core components: the freelance worker’s level of control over their own work and the worker’s opportunity for gain or loss. According to the Department of Labor, the actual practice of the working relationship is the essential piece that determines whether someone is an employee.

Because gig workers aren’t always classified as employees, companies aren’t obligated to provide them with the same benefits. These classification issues can cause problems related to taxes, which are already complicated enough. The tax process is often confusing, and changing tax regulations surrounding the gig economy don’t make things any easier.

In the past, the reporting threshold for gig workers was $20,000 in annual income across 200 transactions. Starting in 2022, the 1099-K reporting threshold is $600 in annual income — with no minimum number of transactions required. For people selling goods on Etsy, for example, that means they’ll receive a 1099-K form when their annual income on the platform surpasses $600. For businesses, it means keeping closer track of gig worker income and doing more robust reporting.

Taxes vary from state to state

Despite changes to the federal tax laws regarding the gig economy, gig workers and the businesses that employ them need to be aware of the tax codes of their states. For example, California is in the process of creating requirements for reporting gig worker income. Meanwhile, states like Arkansas, Missouri, New Jersey, and Vermont — as well as the District of Columbia — have established their own thresholds.

Additionally, the way freelancers go about their work has an impact on their taxes. Almost every state in the U.S. has its own income tax for freelancers and businesses; in most states, you’ll pay your state income taxes during the year as estimated taxes. If a freelancer is working as an independent business, like an LLC, those taxes are also subject to change from state to state — and sometimes even from city to city.

What this means for small businesses

Even if freelancers are responsible for paying self-employment taxes, you still have company tax obligations. Here’s how to ensure you meet your obligations:

1. Understand how the tax system works

While this can be confusing, it’s an essential part of working with freelancers. Your company needs to know its tax obligations, such as withholding taxes, keeping records, and providing freelancers with the information they need. When remote work comes into the mix, it’s also important to know where your freelancers work because tax laws change based on state lines.

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2. Classify workers properly

Misclassification of workers is one of the biggest problems in the gig economy. Freelancers and gig workers don’t have the same benefits as traditional employees, but the laws governing the gig economy are changing. 

The contractual agreement is becoming less important as regulatory bodies start to look at the nature of the work itself, how much control gig workers have over the work they do, their involvement in the company, and how permanent the relationship might be. If you’re not classifying your workers properly, your business might be subject to some hefty fines.

3. Invest in robust record-keeping

You’re responsible for more than just a freelancer’s hourly rate. As tax laws change and place a greater responsibility on companies to report freelancer earnings to individual workers — your company needs to have the tools in place to provide the right information for freelance tax reporting. 

These changes are also making compliance more of a concern. Some larger companies have already been criticized for not providing freelancers with the documentation they need to file their taxes properly. As regulations tighten, make sure your business is prepared.

4. Look at the future of freelancing

The gig economy still offers benefits for companies, but it’s going to be important to stay on top of changing regulations as it continues to mature. Freelance work is becoming more popular and can be a great tool for businesses — particularly small businesses that lack the capacity to take on multiple full-time employees and that don’t want to pay individuals when there’s no work available. But it only pays dividends if you do it right and continually work to understand your role in gig economy taxes.

Prepare to work with freelancers

We’re at a turning point for freelancers and gig workers, and companies are being held to higher standards regarding their obligations to these independent contractors. The best way to make sure your company continues to run smoothly when working with freelancers is to stay on top of these industry changes. With the right tax tools and knowledge, you’ll be able to make the most of gig workers without any negative consequences.