Is the New IRS Voluntary Classification Settlement Program For You?

On September 22, 2011, the IRS launched its Voluntary Classification Settlement Program ("VCSP"). It affects those employers who know or otherwise believe that they have been improperly classifying independent contractors. The goal of the program is to enable employers resolve past worker classification issues and achieve certainty under the tax law. By voluntarily reclassifying their workers, the IRS believes that employers can proactively correct their mistakes. To not do so exposes such employers to the IRS' liabilities directly stemming from forced reclassification.

IRS reclassification of an employee occurs where persons claimed as independent contractors are re-categorized by the IRS as Form W-2 employees. This reclassification is often the result of an audit, or employee complaint. The imposition of fines, penalties and back-taxes for which the employer is liable can be severe. For this reason, it is important that business owners ensure the proper classification of their workers in order to avoid an unwelcome change by the IRS. It therefore behooves an employer to look at his workforce under the three main guidelines outlined by the IRS. These being, behavioral and financial control along with relationship of the parties. As an employer, you want for you and your workers to be clear as to how their compensation is calculated, how often it is paid and what benefits are related to it. Also, that you are classifying people working in similar jobs in the same manner.

The VCSP is available to businesses, tax-exempt organizations, and government entities who are presently improperly classifying their workers, or a class of workers as nonemployees or independent contractors. The program will give employers the opportunity to achieve compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit. It is also part of a wider effort by the IRS to help give taxpayers a fresh start with their tax obligations.

Eligibility

To be eligible for the VCSP, an applicant must have:

  1. Consistently treated workers in the past as nonemployees,
  2. Filed all required Forms 1099 for the workers for the previous three years
  3. Not currently under audit by the IRS , by the Department of Labor or a state agency concerning the classification of these workers
  4. File Form 8952 (Application for Voluntary Classification Settlement Program), at least 60 days before one wants to begin treating workers as employees.

Effects of Applying for the VCSP

By participating in the VCSP, an employer is agreeing to prospectively treat his/her workers as employees for future tax periods. In exchange, the employer will pay a penalty in the amount of 10 percent of their employment tax liability due on compensation paid to the workers for the most recent tax year to the IRS. See, IRC Sec. 3509.

In calculating the employment tax liability and the corresponding penalty, the employment tax rate for compensation up to the Social Security wage base is 10.68% for 2010, 10.28% for 2011, and 3.24% for compensation above the Social Security wage base. Thus, starting with an employment tax rate of 10.68%, if as an employer you paid $1,000,000 in wages, your employment tax liability will be $106,800. The one-time penalty to be paid under the VCSP program will be 10% of the employment tax of $106,800, or $10,680.

In return for enrolling in VCSP and paying the penalty, the employer will not be subject to an employment tax audit with respect to their worker classification for prior years. However, the IRS will require the employer to agree to extend the statute of limitations on assessment of employment taxes. Instead of the usual three years that generally applies to payroll taxes, the period will be extended to six years.

Application Process

Eligible Taxpayers who wish to participate in the VCSP must submit an application for participation in the program. Along with the application, the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848) must be provided. The IRS will contact the Taxpayer or authorized representative to complete the process once it has reviewed the application and verified the Taxpayer's eligibility. Taxpayers whose applications have been accepted will enter into a closing agreement with the IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.

Conclusion

Classifying workers as employers or independent contractors is not always straightforward. Business owners faced with the delicate task of classifying workers as either employees or independent contractors may be best advised to speak with their tax counsel about the VCSP to find out whether they are good candidates for the program and how they may take advantage of it.

Chaya Kundra, Esq.

Kundra & Associates, P.C.

301-637-8130