Is the IRS’s Program for Misclassified Workers Right for Your Business?

The IRS offers an employment tax settlement program called the Voluntary Classification Settlement Program. The program allows employers to reclassify workers they’ve previously treated as independent contractors.

Here are the highlights:

• Employee or Independent Contractor? Whether an employer classifies a worker as an employee or as an independent contractor makes a big difference for federal income tax and employment tax purposes. If a worker is an employee, the employer must withhold federal income tax and FICA taxes, pay the employer’s share of FICA taxes and the FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well.

None of those obligations apply for workers who are independent contractors. Instead, the business merely sends each independent contractor a Form 1099-MISC for the year showing what they were paid, if that amount is $600 or more.

In general, individuals are generally employees if the enterprise they work for has the right to control and direct them regarding the job they are to do and how they are to do it. Otherwise, the individuals are independent contractors.

• Who is Eligible? The VCSP is available to taxpayers who have consistently treated their workers as independent contractors and now want to treat them as employees. To be eligible, the taxpayer must have filed all required Forms 1099 for the workers for the previous three years within six months of the Form 1099 due dates. That includes extensions.

A taxpayer who the IRS or Department of Labor is currently auditing isn’t eligible for the program. You can see other eligibility requirements on the IRS’s website.

• Terms of the Program. A taxpayer accepted into the VCSP must agree to treat workers as employees for future tax periods. The taxpayer must also agree to allow IRS an extra three years to assess employment taxes.

In exchange for making these concessions, the taxpayer:

• Only has to pay 10% of the employment tax liability on compensation paid to the workers for the most recent tax year, determined under reduced rates.
• Will not be liable for any interest and penalties on the employment taxes.
• Will not be subject to an employment tax audit for the classification of the workers for prior years.

Taxpayers may choose to reclassify some or all of their workers. However, once a taxpayer chooses to reclassify certain workers as employees, it must treat all workers in the same class as employees.

• Figuring the Payment Due: The payment due under the VCSP is 10% of the employment taxes. Those taxes are calculated under reduced rates on the reclassified workers’ compensation in the most recently completed tax year. That amount is determined at the time the VCSP application is filed.

Taxpayers who are accepted into the VCSP must enter into a closing agreement with IRS. Full payment is due when the taxpayer returns the signed closing agreement to the IRS.

• Should You Participate in the VCSP? Although the VCSP’s terms are generous, you should carefully weigh the costs and benefits before deciding to take part in the program. Agreeing to treat workers as employees may have far-reaching consequences under a variety of federal and state statutes. The right choice may depend on how clear it is that your workers are, in fact, employees.

Talk to us about the pros and cons of participating in the VCSP. If participation is right for you, we can help you fill out an application and negotiate a closing agreement.