IRS’s Voluntary Classification Settlement Program: Correcting Worker Misclassification
It can be difficult to determine whether a worker is performing services as an employee or independent contractor, but that distinction has a significant affect on a company’s employment tax liability.
On September 21, 2011, the Internal Revenue Service (IRS) announced a new program that will allow businesses to voluntarily reclassify certain workers—from independent contractor to employee status—by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit. This Voluntary Classification Settlement Program (VCSP) offers relief for businesses that may have misclassified workers in the past and may therefore be liable for significant additional taxes, penalties, and interest.
Recently, the IRS has focused on employment taxes with a particular emphasis on worker classification issues—an issue that has become more urgent as taxing authorities seek additional revenue to offset large budget deficits. The IRS and the Department of Labor (DOL) entered into a joint initiative to improve compliance with both IRS and DOL laws and regulations. The two entities will share information and collaborate to help reduce the incidence of misclassification of employees as independent contractors, and to improve compliance with labor and tax laws.
The Voluntary Classification Settlement Program (VCSP)
Under the VCSP, eligible employers can obtain relief from federal payroll taxes, penalties, and interest they may owe for the past, if they prospectively treat workers as employees. The VCSP is available to businesses (including exempt organizations) that have been uncertain whether to treat their workers or a class or group of workers as employees or independent contractors, and now want to correctly treat these workers as employees.
To be eligible for the VCSP, an employer must have:
- consistently treated the subject workers as non-employees in the past
- filed all required Forms 1099 for the workers for the previous three years, and
- not be under audit by the IRS, the Department of Labor, or a state agency concerning the classification of these workers.
If an eligible employer agrees to prospectively treat a class of workers as employees, its employment tax liability will be only 10% of the amount that would have been due if the workers were treated as employees during the most recent tax year, using the reduced rates available under Section 3509 of the Internal Revenue Code (these rates include federal income tax withholding and employer/employee social security and Medicare tax). Therefore, the VCSP generally allows an employer to settle employment tax liabilities for misclassified workers for slightly more than one percent of the total compensation paid to the workers. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years.
Applying for the Program
To apply for the VCSP, an employer must submit an application using IRS Form 8952 Application for Voluntary Classification Settlement Program, at least 60 days before it wants to begin treating the workers as employees.
Additional Program Requirements
Under the program, an employer does not have to reclassify all of its workers who are currently treated as non-employees. However, once an employer chooses to reclassify certain of its workers as employees, all workers in the same class (those who perform the same or similar services) must be reclassified as employees and must continue to be treated as employees in the future.
In addition to filing Form 8952, participating employers must sign a closing agreement with the IRS extending the usual three year statute of limitations to six years for the first three calendar years after the agreement is signed.
If you have concerns about the current classification of your workers or if you are interested in participating in the Voluntary Classification Settlement Program, please contact Dana Ingols at Frank, Rimerman + Co. LLP. at [email protected].