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Business Law

The IRS's Voluntary Classification Settlement Program

In September 2011, the IRS announced the launch of a Voluntary Classification Settlement Program (VCSP) to allow employers to resolve prior worker classification issues and achieve certainty under the tax law. Classification issues arise because an independent contractor is responsible for its own taxes, and the business pays no payroll taxes or unemployment taxes on behalf of the contractor. On the other hand, with employees, the business pays federal and state unemployment taxes and also pays half of the employee's Social Security and Medicare payroll taxes. For these reasons, businesses often try to classify their staff as independent contractors.

The Internal Revenue Service investigates misclassification of employees as independent contractors, and can require payment of the payroll and unemployment taxes as well as interest and penalties when businesses are unable to justify the independent contractor designation. The potential expenses and the time spent away from the primary business during an audit can cost business owners and their advisers everything. Indeed, even state legislatures are cracking down on misclassification. For example, as of January 1, 2012, California enacted S.B. 459, under which business owners and non-lawyer consultants may be punished by a civil penalty of up to $25,000 for each willful misclassification. Even those misclassified can seek additional damages from the business owners and non-lawyer consultants in the form of a class action lawsuit.

In light of the potentially grave consequences of misclassification and as part of a larger "Fresh Start" initiative at the IRS to help taxpayers and businesses address their tax responsibilities, the IRS enacted the VCSP. Under the VCSP, eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past, if they prospectively treat workers as employees. Instead of waiting for an IRS audit, employers will make a minimal payment effectively equaling just over one percent of the wages paid to the reclassified workers for the past year to cover past payroll tax obligations. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.

Interested employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before they want to begin treating the workers as employees. To be eligible, an applicant must:

  • Consistently have treated the workers in the past as nonemployees,
  • Have filed all required Forms 1099 for the workers for the previous three years, and
  • Not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers

Eligible taxpayers accepted into the VCSP will enter into a closing agreement with the IRS to finalize the terms of the VCSP, and will simultaneously make full and complete payment of any amount due under the closing agreement. To discuss the option of a voluntary settlement and its consequences for your business, please contact us.

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