On September 21, 2011, the Internal Revenue Service (“IRS”) announced its new Voluntary Classification Settlement Program (“VCSP”). Under VCSP, eligible employers can receive relief from payroll taxes otherwise owed in exchange for agreeing prospectively to treat such workers as employees.
Whether a worker is performing services as an employee or an independent contractor depends upon the facts and circumstances and is generally determined under the common law test of whether the service recipient has the right to direct and control how the worker performs the services. In many situations, the determination of the proper worker classification status under the common law can be far from clear.
For taxpayers under IRS examination, the current Classification Settlement Program (“CSP”) is available to resolve federal employment tax issues related to worker misclassification, if certain criteria are met. CSP permits the prospective reclassification of workers as employees with reduced federal employment tax liabilities for past non-employee treatment. The CSP allows employers and tax examiners to resolve the worker classification issues as early as possible in the administrative process, thereby reducing taxpayer burden and providing efficiencies for both the taxpayer and the Government.
IRS decided that in order to facilitate voluntary resolution of worker classification issues and achieve the resulting benefits of increased tax compliance and certainty for taxpayers, workers and the Government, it would be beneficial to provide taxpayers with a program that allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes.
In order to be eligible for the new settlement program, the employer must have filed Form 1099 for each worker for the past three years and not be currently under audit by IRS, the Department of Labor or any state government agency.
If the employer agrees to treat the workers as employees, the employer will be liable for only 10 percent of liability due for the most recent tax years in accordance with reduced rates under Section 3509 of the Internal Revenue Code, but will not be liable for any penalties and interest and will not be subject to audit for employment tax issues with respect to the worker classification of such workers for prior years. Employers participating in the program will also be required to extend the statute of limitations for assessment of employment taxes for three years beginning after the date the employer has agreed to begin treating the workers in issue as employees.
Employers participating in the VCSP will be required to enter into a closing agreement with IRS.
Significant Benefits and Advantages
Under the appropriate facts and circumstances, many business taxpayers may find it beneficial to pursue VCSP, but like so many other tax considerations and dealings with IRS, such decisions should be made on a case-by-case basis with the advice of tax counsel, who should weigh and balance various considerations, factors and risks.
One of the most important advantages of the VCSP is that it requires only three years of Forms 1099 being filed for each worker to be reclassified, rather than the rules required under so-called “Section 530” relief (referring to Section 530 of the Revenue Act of 1978, not to the Internal Revenue Code), requiring Forms 1099 to have been filed for all years after 1978. Moreover, relief under Section 530 is only available if the employer had a “reasonable basis” for treating a worker as an independent contractor. Significantly, no such “reasonable basis” is required under VCSP, representing a remarkable liberalization that will no doubt open the VCSP to a much greater number of taxpayers.
Another obvious benefit of VCSP is the waiver of all penalties and interest, which could be very substantial in many instances.
An additional advantage provided under VCSP is that the taxpayer will not be subject to an employment tax audit concerning the reclassified workers for prior years. However, it is important to note that the IRS would not be prevented from conducting a tax audit of the taxpayer on other issues.
All in all, VCSP promises to be a program well worth considering for many businesses who have misclassified workers as independent contractors.