The issue of whether a worker should be treated as an employee or an independent contractor has been an area of significant IRS interest for decades. The IRS has the ability to assess significant employer penalties for failure to withhold employment and income taxes on a worker who should have been treated as an employee.
If an employer is faced with this issue upon an IRS examination, the IRS will typically offer to settle the penalties at a discounted rate under Internal Revenue Code (IRC) Section 3509. This assessment can be substantial, particularly if the employer has a significant number of workers who have been misclassified for employment tax purposes.
Employers that are not under IRS audit, who believe that they have misclassified some of their workers as independent contractors, now have the ability to correct the issue at a lower cost. On September 21, 2011, the IRS issued Announcement 2011-64, creating a new program that allows employers to voluntarily treat misclassified workers as employees on a going forward basis and pay a reduced penalty.
The Voluntary Classification Settlement Program (VCSP) will allow employers to pay a penalty of 10% of the employment tax liability determined in accordance with IRC Section 3509. The employer must also agree to treat the workers as employees in the future.
To be able to participate in the VCSP, the employer must meet three tests:
· The employer must have consistently treated the workers as independent contractors or non-employees.
· The employer must have filed all required IRS Forms 1099 for the three preceding calendar years; it is interesting to note VCRS does not say that the Forms 1099 had to be filed on a timely basis.
· The employer must not currently be under audit by the IRS for any purpose, or under audit by the Department of Labor (DOL) or any state government agency on the topic of worker classification.
The 10% penalty rate is a significant discount from amounts that could be imposed by the IRS for those employers who cannot use the VCSP. An example provided by the IRS (which can be found at http://www.irs.gov/businesses/small/article/0,,id=246014,00.html) demonstrates that a penalty of approximately $ 160,000 imposed under IRC 3509 is reduced by 90% under the VSCP.
Participation in the VCSP occurs through the submission of new IRS Form 8952, “Application for Voluntary Classification Settlement Program (VSCP)”. Upon acceptance by the IRS, a closing agreement will be entered into and the penalty will be paid in full at that time.
The VCSP does not deal with the impact of worker re-classification as employees for participation in employee benefit plans offered by the employer. Failure to provide benefits to employees in retirement programs which are intended to be qualified under IRC 401 can cause a number of issues; welfare plan participation can also be an issue. Employers should consider all of the ramifications of a VSCP filing before taking that step.
For more information, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.