IRS Program for Misclassified Workers | Is the IRS’ Voluntary Classification Settlement 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 previously treated as independent contractors.
Here are the highlights:
Employee or Independent Contractor? Whether an employer classifies a worker as an employee or an independent contractor makes a big difference for federal income and employment tax purposes. If a worker is reclassified as 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 that it makes available to other employees. There may be state tax obligations as well.
None of those obligations apply to 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 very general terms, 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 consistently treat their workers as independent contractors and now believe them to be employees.
Caution. As part of the reclassification, the business owner will attest to the following;
A Treatment of Workers
1 Taxpayer wants to voluntarily reclassify certain workers as employees for federal income tax withholding, Federal Insurance Contributions Act, and Federal Unemployment Tax Act taxes (collectively, federal employment taxes) for future tax periods.
2. Taxpayer is presently treating the workers as non-employees.
3. Taxpayer has filed all required Forms 1099 for each of the workers to be reclassified for the three preceding calendar years ending before the date of this application.
4. Taxpayer has consistently treated the workers as non-employees.
5. There is no current dispute between the Taxpayer and the IRS as to whether the class or classes of workers are non-employees or employees for federal employment tax purposes.
B Examination
1. Taxpayer or, if applicable, any member of the Taxpayer’s affiliated group is not under employment tax examination by the IRS.
2. Taxpayer is not under examination by the Department of Labor or any state agency concerning the proper classification of the class or classes of workers.
3a. Taxpayer has not been examined previously by the IRS or the Department of Labor concerning the proper classification of the class or classes of workers; or,
3b. Taxpayer has been examined previously by the IRS or the Department of Labor concerning the proper classification of the class or classes of workers, and the Taxpayer has complied with the results of the prior examination.
IMPORTANT: 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 for the most recent tax year, determined under reduced rates which equates to a little over 1%
- 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 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 participate in the program. The right choice may depend on how clear it is that your workers are, in fact, employees. Agreeing to treat workers as employees may have far-reaching consequences under a variety of federal, state, and Department of Labor statutes.
Talk to us about the pros and cons of participating in the VCSP. If participation is right for your business, we can help you fill out an application and negotiate a closing agreement.