Labor&Employment Personnel FileBoth the federal and various state governments in recent years have significantly increased their enforcement of worker classification laws. These laws all address the question of whether a particular worker should be classified as an independent contractor or an employee. Companies that have been audited by the federal and state governments and found to have misclassified workers have faced large back employment tax liabilities, interest, and penalties.
In a new twist on enforcing federal worker classification laws, the Internal Revenue Service recently announced a new Voluntary Classification Settlement Program (VCSP). The VCSP “provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes.” As the name implies, VCSP is a voluntary program.
To be eligible for VCSP, an employer must (1) have consistently treated the workers to be reclassified as independent contractors; (2) have filed all required IRS Form 1099 for the workers to be reclassified for the previous three years; and (3) not currently be under IRS or state audit for misclassification of workers.
Employers may apply for VCSP using IRS Form 8952. Among the information required to be disclosed on the Form 8952 is (1) the number and description of the classes of workers to be reclassified; (2) the total taxable compensation paid to the soon-to-be reclassified workers for the most recently closed tax year; and (3) the estimated federal employment tax liability for those workers.
The IRS has discretion as to whether it chooses to accept any VCSP application. If an employer is accepted into the program and ultimately signs a settlement agreement, the employer must prospectively treat the reclassified workers as employees. Employers also receive the following benefits: (1) the employer’s federal employment tax liability will be limited to only ten percent (10%) of the total federal tax liability for the most recently closed tax year and the employer must pay this amount; (2) the employer will not be liable for any interest or penalties on the ten percent payment; and (3) the employer will not be subject to a federal employment tax audit with respect to the workers being reclassified.
While the VCSP has the potential advantage of limiting federal employment tax liability and removing the specter of future federal audits for the reclassified workers, there are a number of potential risks. First, if the IRS chooses not to accept an employer’s application – for any reason – the employer has effectively identified itself as a potential target for future IRS audits and provided the IRS, under penalty of perjury, with the raw information needed to start an audit. Second, the VCSP only applies to potential federal employment tax liability. VCSP participation does not and cannot provide any protection again state audits or state employment tax liabilities. Once workers are identified as misclassified as part of VCSP, employers face not only possible state employment tax liabilities, but also possible liability under various state workers compensation and unemployment insurance laws.
Employers interested in participating in the IRS’s new VCSP should consult with legal counsel and their tax advisors to determine (1) whether VCSP is right for them and, if so, (2) how best to plot a course through the labyrinth of federal and state employment laws so as to maximize the benefits of VCSP and minimize the downside risks of VCSP rejection and/or audit by state governments.
This article was written by Michael Schrier, Jackson Kelly, PLLC.
