• IRS Gives Employers A Fresh Start Opportunity for Misclassifying Employees
  • October 3, 2011 | Authors: Shawn R. O'Brien; Karen Hughes Rodrigues
  • Law Firms: Jackson Walker L.L.P. - Houston Office ; Jackson Walker L.L.P. - Dallas Office
  • The IRS recently launched a new program to give employers a "fresh start" for prior acts of misclassifying "employees" as "independent contractors" by allowing employers to pay minimal taxes and avoid interest and penalties.  The Voluntary Classification Settlement Program ("VCSP") was announced on September 21, 2011, providing employers an opportunity to voluntarily reclassify independent contractors as employees, if appropriate.

    Why Participate?

    Many businesses, tax-exempt organizations and government entities currently misclassify their workers as independent contractors, and by doing so, these employers are subjecting themselves to substantial taxes, penalties and interest if uncovered by the IRS.  Under the IRS' new program, eligible employers may obtain substantial relief from taxes, penalties and interest for prior tax years if such employers agree to properly classify workers as employees on a prospective basis.

    Significant Tax, Interest and Penalty Relief

    Participation in the VCSP assures that an eligible employer: (i) will pay only 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year; (ii) will not be liable for any interest or penalties on such tax liability; and (iii) will not be subject to an employment tax examination with respect to the worker classification of such workers for prior tax years.

    Program Eligibility and Requirements

    Employers are eligible to participate in the VCSP if such employer:

    1. Consistently treated workers as independent contractors or other nonemployees;

    2. Filed all required Forms 1099 for such independent contractors and other nonemployees for the previous three years;

    3. Is not currently under audit by the IRS;

    4. Is not currently under audit concerning the classification of such independent contractors and other nonemployees by the Department of Labor or by a state governmental agency; and

    5. Is in compliance with the results of any previous audit by the IRS or the Department of Labor concerning the classification of independent contractors and/or other nonemployees.

    If an employer meets such eligibility requirements, the employer must then:

    1. File IRS Form 8952, Application for Voluntary Classification Settlement Program (VCSP) at least sixty (60) days prior to when the employer would like to begin classifying any independent contractors as employees;

    2. Prospectively treat the subject class of workers as employees for future tax periods;

    3. Extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the employer has agreed to begin treating such workers as employees; and

    4. Enter into an IRS VCSP Closing Agreement.

    Evaluating Participation in the VCSP

    Secretary of Labor Hilda Solis recently signed memoranda of understanding with the IRS and several states aimed at improving state and federal cooperation and coordination on employee misclassification compliance and education.  While the VCSP provides participating employers with amnesty and resolves the classification issue for federal employment tax purposes, it remains unclear whether agencies other than the IRS will offer amnesty opportunities to reclassify employees prospectively.

    It is also unclear what information the IRS intends to share with other agencies.  Typically, such agencies share information relevant to law enforcement initiatives and investigations.  Accordingly, employers who utilize independent contractors or other nonemployees and who are interested in participating in the VCSP should consult with their tax advisors to determine eligibility in the program and, likewise, should consult their labor and employment attorneys to discuss potential non-tax consequences — wage-hour implications, union-related issues, effect on employee benefits, leaves of absence eligibility, worker's compensation coverage, etc. — that might arise as a result of participating in the VCSP.