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Monthly Tax Tip: Worker Classification Disclosure

Author: Robb A. Longman Date: 10/31/2011

Categories: Employment Law & Litigation, Tax Services

The IRS recently announced a new voluntary settlement program for employers that have misclassified their employees as independent contractors or other nonemployees. The Voluntary Classification Settlement Program (VCSP) offers employers a significantly reduced penalty framework, as well as audit protection for previous years, in exchange for agreeing to prospectively treat any and all misclassified workers as employees. The program began in September 2011 and, to date, a termination date has not been announced.

Worker classification determines if an individual providing services for a business is an employee or independent contractor. The purpose of worker classification is to properly classify compensation for services rendered.

Worker classification has important federal and state tax consequences. For statutory employees, employers are responsible to withhold and pay income tax and employment taxes (FICA and FUTA) on wages paid to employees. By contrast, an independent contractor is solely responsible for the payment of taxes on his or her earnings. Because an employer is required to withhold employment taxes from the wages of employees, failure to do so can result in liability for unpaid withholding, FICA and FUTA taxes as well and penalties. In addition, Employers may be liable for worker compensation premiums and liability claims as well as state unemployment taxes.

The VCSP allows employers currently treating their workers, (or a class or group of workers), as independent contractors to acknowledge the misclassification and convert their status to statutory employees going forward with minimal adverse consequences from the IRS. The requirements of VCSP are:

  1. The employer must have treated the workers as nonemployees, and filed all required information returns such as Forms 1099 for the workers for the three (3) preceding calendar years. An employer qualifies whether or not the misclassification was the result of a close call in judgment or a clearer cut misinterpretation of the law;
  2. The employer cannot currently be under audit by the IRS or Department of Labor (“DOL”) for work classification; however, an employer previously audited by the IRS or DOL concerning worker classification may request to participate in the VCSP if the employer has complied with the results of the previous audit;
  3. The employer must extend the period of limitations on assessment of employment taxes for three (3) years to include the first, second and third calendar years following the date on which the employer agrees to begin treating the workers as employees. In most cases, this is an inconsequential concession;
  4. The employer must request to participate by filing Form 8952, Application for Voluntary Classification Settlement Program. The IRS has advised employers to file Form 8952 at least sixty (60) days from the due date on which the employer wants to begin treating its workers as employees; and
  5. Employers must apply for acceptance into the program by the IRS. If the IRS does not accept the employer based upon the initial Form 8952 filing, the employer may refile.

In exchange for agreeing to prospectively treat workers as employees, employers will only have to pay ten percent (10%) of the employment tax liability that may have been due on compensation paid to workers in the most recent year and twenty percent (20%) of employee social security taxes. Employers also will not be assessed any interest and penalties on the liability, and will not be subject to an employment tax audit with respect to the classification of the workers for prior years.

Since this is a new program, there still remain questions about its process and whether or not states will comply with the program. Deals such as this, however, are not generally seen from the IRS. Employers should act promptly while the opportunity is available.