In 2011, the IRS launched the Voluntary Worker Classification Settlement Program (VCSP). This program enabled certain employers who had been misclassifying their employees as independent contractors to voluntarily admit their wrongdoing and begin correctly classifying their workers as employees, all while avoiding much of the tax, interest, and penalties that the IRS would normally impose. Recently, the IRS announced certain beneficial permanent and temporary modifications to the VCSP that employers should take advantage of immediately.
CLASSIFICATION AND MISCLASSIFICATION OF WORKERS
For federal employment tax purposes, workers are classified as either employees or independent contractors. Whether a worker is an employee or an independent contractor is not the employer’s option; instead, it is dependent on several factors that have been developed through the Internal Revenue Code, Treasury Regulations, and Federal case law. If a worker is classified as an employee, the employer is responsible for paying its share of that worker’s FICA taxes and for withholding income and FICA taxes from the employee’s wages and paying these amounts to the IRS. On the other hand, if a worker is an independent contractor, the employer has no employment tax obligations and the worker generally is subject to self-employment taxes on his or her earnings. For this reason, in many instances it is advantageous for employers to classify their workers as independent contractors rather than employees.
When the IRS discovers that an employer has misclassified its workers as independent contractors, that employer may be subject to substantial costs, including the payment to the IRS of any employment taxes that would have been due if the workers had been classified as employees, penalties, and interest. In addition, the individuals that were responsible for the employer’s wrongdoing may be held personally liable for amounts that should have been withheld from the workers’ wages and paid to the IRS but were not.
RELIEF FROM LIABILITY
Employers that have a reasonable basis for misclassifying employees as independent contractors may be eligible for complete relief from past-due employment taxes or for the payment of past-due employment taxes at a reduced rate. Such relief is not available to employers that knowingly and intentionally misclassified their workers. The only option for these employers to reduce their potential exposure is by participating in the VCSP.
If an employer meets the VCSP requirements and enters into a closing agreement with the IRS affirming that it will treat the workers in question as employees in the future, such employer’s liability for past-due employment taxes will be limited to 10% of the liability that would have been due on compensation paid to workers in the most recent tax year only. Effectively, employers will be required to pay to the IRS an amount equal to just over 1% of wages paid in the previous year. Moreover, the employer will not be subject to any interest or penalties on these unpaid taxes and will not be subject to IRS employment tax audits with respect to worker classification for previous years.
CHANGES TO VCSP ELIGIBILITY
Until recently, to be eligible for participation in the VCPS, employers:
1) Must have consistently treated their workers (or a certain group of its workers) as independent contractors;
2) Must have issued all required forms 1099 to these workers for the past three years;
3) Must not have currently been under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers; and
4) Must agree to extend the period in which the IRS can make additional employment tax assessments.
Based on comments and concerns of taxpayers and their representatives, the IRS decided to expand the number of employers eligible to participate in the VCSP. First, the IRS changed the third requirement related to employers undergoing an audit. Now, taxpayers that are under an IRS audit that is not related to employment taxes are eligible for participation in the VCSP program, assuming they meet the other requirements. Second, the IRS eliminated the requirement that employers agree to extend the IRS’s statute of limitations on assessment of employment taxes.
Finally, in a major expansion of VCSP eligibility, the IRS temporarily will permit employers that have not filed all required forms 1099 in the most recent three years to participate in the VCSP if they agree to reclassify their workers prospectively and file any forms 1099 that went unfiled with respect to the workers being reclassified for the previous three years. In addition, in place of the standard VCSP payment of 10% of the most recent year’s employment tax liability, these employers will be required to pay 25% and a penalty based on the number of forms 1099 were not timely filed. This temporary expansion expires on June 30, 2013.
Obviously, the VCSP is a great opportunity for employers who have been misclassifying their workers (intentionally or unintentionally) to correct prior non-compliance and begin complying with their federal tax obligations with minimal cost. For more information about the VCSP, please refer to IRS Announcements 2012-45 and 2012-46 and contact Joshua Nesser of Lavelle Law, Ltd. at 847-241-1778.