Are you currently treating your worker(s) as an independent contractor but, after some careful consideration, think that maybe they should have really been classified as an employee? Are you concerned about the potential employment tax liability due to reclassifying a worker from an independent contractor to an employee?

Over the next year, the IRS will randomly select organizations to analyze whether workers are properly classified as employees or independent contractors. The IRS will likely rely on the 20 Common Law Factors (Rev. Rul. 87-41) and their IRS Training Materials, both of which can be found on the IRS website, to guide them in making their determination.

Employers who treat a worker as an employee are required to withhold federal income tax and Social Security and Medicare tax upon payment to such individual. On the other hand, employers are not required to do so for payments to independent contractors. If an employee is misclassified as an independent contractor, the employer can be subject to not only the employer’s share of employment taxes but the employee’s share as well, plus penalties and interest. Therefore, it is very important for employers to classify their workers properly from the beginning.

In September 2011, the IRS launched a new program to give employers the opportunity to voluntarily reclassify workers as employees for federal employment tax purposes. The Voluntary Classification Settlement Program (“VCSP”) allows eligible employers the opportunity to voluntarily reclassify an individual as an employee for future tax periods with limited federal employment tax liability for past non-employee treatment and without going through lengthy administrative processes.

To be eligible for the VCSP, an employer must:

  • Want to voluntarily reclassify workers as employees,
  • Currently be treating their worker (or a class or group of workers) as a non-employee,
  • Consistently have treated the worker as a non-employee,
  • Have filed all required Forms 1099 for the workers for the last three years.
  • Not be currently under audit (whether for employment or income tax, or Form 990 reporting) by the IRS, and...
  • Not be currently under audit concerning the classification of the worker by the Department of Labor or state government agency unless the employer has complied with the results of the previous

Employers who are interested in participating in the VCSP are required to submit Form 8952, Application for Voluntary Classification Settlement Program at least 60 days before the date the employer wants to begin treating its worker as an employee. Upon review and acceptance by the IRS, the IRS will contact the employer to enter into a closing agreement and finalize the terms and payment of amount due. The    VCSP concerns future tax years only; therefore, the employer is not making any representation for the worker’s status in prior years and the IRS is not making any determination on prior years as well. The IRS has stated that it will not share information about VCSP applicants or applications with the Department  of Labor. Taxable corporations, exempt organizations, as well as governmental entities are all eligible to participate in VCSP.

In exchange for participating in the VCSP, employers agree to prospectively treat workers as employees and will be liable for only a small portion of the taxes they would have been liable for had they not participated in the program and the IRS had found the improper treatment. The taxes the IRS agrees to accept are only ten percent of the employment tax calculated under the reduced rates of IRC §3509(a). The reduced rates apply on the compensation paid to the worker for the most recently completed tax year. For example, on compensation of $1,500,000 in 2010 to workers, you may save more than $144,000 of employment taxes under the VCSP. Under §3509(a), the total employment tax rate is 10.68%. Thus, the employment taxes applicable to the $1,500,000 would have been $160,200 (10.68% of $1,500,000), which under the VCSP, would be reduced to 10% of $160,200 or only $16,020.

In addition, employers will not be liable for any penalties and interest and will not be subject to an employment tax audit with respect to the worker classification for prior years. However, employers must agree to extend the statute of limitations for three years beginning after the date on which the employer has agreed to begin treating the worker as an employee.

For more information about the Voluntary Classification Settlement Program, see, reach out to us or speak to your tax advisor.

Maxine Romano can be reached at 215-441-4600, or Email.