The IRS has announced an opportunity for employers to reclassify employees that have been incorrectly reported to the IRS as independent contractors. There is a 20-point test that the IRS uses to classify workers as employees or independent contractors. These criteria can be viewed on IRS Form SS-8. This form can be utilized as a guideline or can be completed and returned to the IRS for a determination.
Generally speaking the issue of employee or independent contractor hinges on the amount of control exercised by the employer over the worker. If a worker is classified as an employee, the employer must withhold social security, Medicare, and income taxes from wages and also pay the 7.65% employer’s share of social security and Medicare. By classifying workers as independent contractors the employer can save the 7.65% of social security and Medicare. However, if the worker is misclassified and should be an employee, this is illegal and can subject the employer to payment of the tax plus penalty and interest on the unpaid amounts.
Under the IRS Voluntary Classification Settlement Program (VCSP), qualifying employers may report these misclassifications to the IRS and pay 10 percent of the employment tax liability that may have been due for the most recent tax year. For this purpose, IRC 3509(a) specifies a rate of 10.68% which includes a portion of the taxes that should have been withheld from the employee. No penalties and interest will be assessed. In addition, the IRS will not subject the employer to an employment tax audit with respect to the worker classification of workers for prior years. In exchange, the employer agrees to extend the statute of limitations of the assessment of employment taxes from three to six years for the first three years after entering into the program. This applies only to the three years after the workers are properly reclassified. The employer must agree to reclassify workers as employees and should apply at least 60 days before they want to begin treating them as employees.
For an employer who has misclassified workers, this is a tremendous opportunity to get their employment tax issues straight with the IRS at a minimal cost and eliminate the risk of an audit with full taxes, interest, and penalties payable.
In order to qualify the employer must:
1. Currently incorrectly treat some workers or class of workers as independent contractors.
2. Have consistently treated these workers as non-employees and must have properly filed Forms 1099 for the workers for the previous three years.
3. Not currently be under audit by the IRS, the Department of Labor, or a state government agency for worker classification issues.
In order to apply for relief under VCSP, the employer should complete Form 8952. This is a new form that is now available at www.irs.gov. The IRS will then take action on the application and reserves the right to reject or accept each application.
There is apparently one downside to entering this program, aside from the extended statute of limitations. When a worker is misclassified as an independent contractor, the employer also avoids the state unemployment compensation tax. Confessing to the IRS may attract the attention of the state agency handling unemployment compensation issues and result in a liability for unemployment compensation tax, interest, and penalties. Hopefully, some states will be amenable to a negotiated settlement.
The IRS release does not specify a sunset provision on this program, so employers are encouraged to quickly.