Over the last two weeks, we have been discussing misclassifying workers as independent contractor when they are really employees. We have touched on the consequences of such actions and the factors that IRS auditors use to determine whether a worker is an employee or an independent contractor. Many employers using independent contractors are rightly concerned about IRS audits. Many have heard that the IRS has “amnesty” and “safe harbor” programs. Is that true? If so, do they provide any possible break for employers who, for whatever reason, may have improperly classified some or all of their workers? Let’s take a closer look after the jump…
The Voluntary Classification Settlement Program (VCSP)
Along with its decision to crack down on businesses that misclassify employees as independent contractors, the IRS introduced the Voluntary Classification Settlement Program (VCSP) in September 2011 to encourage tax payers to comply with their tax obligations. As the name implies, it is a voluntary program, which ostensibly gives businesses a “fresh start”, and a more lenient penalty framework, in which businesses pay less in back taxes and avoid interest and penalties (leading some to improperly refer to this program as an “amnesty” program) — if they properly reclassify their workers from independent contractors to employees for future tax periods. There is no deadline. Businesses would pay an amount equal to just over one percent of the wages paid to the reclassified worker(s)–again with no penalties or interest. Sounds like a good deal, no? Why wouldn’t/shouldn’t a business jump right on this train? Well, as with anything, one should be aware of all the key provisions and evaluate pros and cons before moving forward.
In a nutshell, the VCSP’s eligibility requirements are as follows:
- The business must have consistently treated the workers in the past as nonemployees (the business does not have to classify – or re-classify all its workers; it can choose to re-classify some and leave others classified as nonemployees, but should be clear as to which groups it will re-classify and be consistent as to those groups).
- The business must have filed all required Forms 1099 for the previous three years (not required for businesses that took advantage of the temporary expansion of the VCSP, which expired June 30, 2013).
- The business must not currently be the subject of an IRS audit concerning employment taxes;
- The business must not currently be the subject of a Department of Labor or state agency audit regarding classification of its workers;
- If the business meets all the above criteria it must treat its previously misclassified workers as employees going forward.
Certain of these requirements are fairly stringent, particularly the filing of Forms 1099 for the previous three years. This requirement alone renders many businesses ineligible. Businesses previously subject to a previous audit who have complied with and are not currently contesting its findings or results may still be eligible to participate in the VCSP if they meet the above criteria. Eligible businesses must complete a Form 8952 and should do so at least 60 days before it intends to treat its workers as employees, to allow time for processing. If the IRS accepts the business’ application, the business will then enter into a closing agreement with the IRS. Again, once accepted the business must agree to treat those workers as employees going forward.
The advantages of participation in the VCSP would seem obvious: businesses would pay no penalties and interest for misclassifications for the time period in question and a fraction of back taxes otherwise owed and will not be audited for prior years for employment taxes regarding worker classification. Before you run to complete that Form 8952 however, make sure you are able and willing to deal with the risks. Here are just a few:
- Just because you apply for participation in this program, doesn’t mean the IRS will accept your application. What happens then? Your business is now on the IRS’s “radar” screen as one that has workers that may be misclassified and may therefore be subject to further investigation by the IRS, potentially leading to increased expense, tax liability for those misclassified workers among other consequences.
- The VCSP only offers protection from the IRS. Participation does not shield a business from Department of Labor or state agency scrutiny regarding classification of workers, and, the IRS is not precluded from sharing information with other government agencies. There are currently no corresponding settlement programs with the Department of Labor or with state agencies.
- VCSP participation might be construed as an admission by the business that third parties may be able to use to its detriment. Form 8952 requires the business to agree that “there is no dispute as to whether the workers are non-employees or employees for federal income tax purposes” and does not indicate that the business and the IRS disagree about the proper classification but have chosen to resolve the issue without addressing the specifics in order to save money, time, etc. The business is effectively forced to admit under penalties of perjury that the workers in question are employees.
So, is the VCSP a way out for employers concerned that they may have improperly classified their workers? To my eye, the jury is still out on that one! As with so many other matters, it will behoove you to look at your specific facts, and engage a competent tax professional (along with your counsel) to determine if it is to your benefit to approach the IRS about participation in this program–and of course, properly evaluate classification of your workers going forward.
In the meantime, here’s a not-s0-random thought for the IRS, Department of Labor and State Agencies: If you’re serious about encouraging businesses to comply with their tax requirements and properly classify their workers, how about establishing corresponding or “joint” settlement programs? It seems that would address concerns about opening oneself up to greater scrutiny (and penalties) from other agencies, thus undermining the benefits and objectives of the VCSP. Just my two cents–without back taxes, penalties and interest, of course!
Since I can’t bear to give you more headaches in one post, I’ll save the discussion on the IRS’s safe harbor provision for the next post! “See” you then!
Disclaimer: Contents of this post are for informational purposes only, are not legal advice and do not create an attorney-client relationship. Always consult with competent local employment counsel on any issues discussed here.
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