In a blog article last month, the importance of properly classifying workers as employees rather than independent contractors was discussed at length.  As discussed, there is often a fine line between the employee and independent contractor classification, and many employers choose the latter in order to save on payroll taxes and employee benefits.  However, this decision can be costly if the IRS conducts an audit and determines that misclassifications have occurred.

To address this issue, on September 21, 2011, the IRS announced it has launched a new initiative to help employers resolve past worker classification issues and achieve certainty under the tax law by reclassifying their workers.  The Voluntary Classification Settlement Program (VCSP) allows eligible employers to voluntarily reclassify their workers for federal employment tax purposes.  The VCSP is optional and provides employers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past “non-employee” treatment.  The VCSP is designed to increase tax compliance and reduce burdens on employers.  It is a part of a larger IRS “Fresh Start” initiative to help taxpayers and businesses address their tax responsibilities.

Qualifying for the VCSP
To be eligible to participate in the VCSP, an employer must have consistently treated the workers as nonemployees (or independent contractors), and must have filed all required Form 1099s for the workers for the previous three years.  Further, the employer must not currently be under audit by the IRS, DOL, or a state agency concerning the misclassification of workers.  Lastly, any employer who had previously been audited by the IRS or DOL concerning the misclassification of workers must have complied with the results of the audit to qualify to participate in the VCSP.

The Benefits of Reclassifying Workers
Most employers know that the cost of getting caught misclassifying employees can be substantial.   If it is determined that workers are misclassified, employers will potentially be on the hook not only for the monetary value of lost fringe benefits, but for the even more substantial back-payments of employment taxes, particularly if penalties and fees are included.

The benefits of participating in the VCSP and agreeing to treat the class of workers as employees for future tax periods are:

The taxpayer will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year;

  • No penalties or interest will be imposed; and,
  • The IRS will not audit the classification of workers for prior years.

It should be noted, however, that participating employers agree to extend the statute of limitations on the assessment of employment taxes by three years for the first, second, and third calendar years beginning after the date the taxpayer agrees to treat workers as employees.  Therefore, employers will be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.

Some Considerations
Prior to participating in the VCSP, employers should review their fringe benefit plans to determine what impact, if any, making a change in employment status for workers might have on the bottom line.  For example, a reclassified independent contractor may become automatically eligible to participate in retirement and health insurance plans once their status is changed to an employee.  It may be advisable to speak to plan providers prior to reclassifying workers to get a clear understanding of the costs associated with reclassification and determine if any amendments need be made to plans.

Applying for the VCSP
Interested employers can apply for the program by filling out Form 8952 “Application for Voluntary Classification Settlement Program” (available at the website) at least 60 days prior to the date they wish to begin classifying workers as employees.  Eligible taxpayers accepted into the program will enter into a closing agreement with the IRS and will be expected to make full and complete payment of any fee or taxes due at the time of signing the agreement.

Ann Kontner is a former senior human resources executive with vast experience in all facets of the HR field. She brings to S&J over 25 years of HR experience in corporate compliance, administrative management, staff development and executive leadership skills. She has worked for a wide range of employers including both public and privately held corporations, federal government contractors, and has experience working in both domestic and international markets.
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