Your business has grown substantially and you can no longer build it on your own. You investigate the cost of hiring help which reveals an employee is expensive. In addition to employer-provided benefits, office space, and equipment, you are required to make payments and contributions on behalf of your employees, including:
• Your share of the employee’s Social Security and Medicare taxes, which totals 7.65% of the employee’s compensation;
• State unemployment compensation insurance, and
• Workers’ compensation insurance.
To circumvent the expense, you decide to hire Independent Contractors (ICs) and for years the business is flourishing until the IRS contacts you and reclassifies your ICs as employees.
The mistake of misclassification can destroy everything that you have worked hard to build and can result in labor law violations and back employment tax liability with years of interest and penalties.
The IRS estimates that millions of workers are misclassified as ICs, depriving the federal government of huge sums of tax revenue. In an effort to narrow the tax gap, the IRS and New Jersey, although this blog will focus on the IRS exclusively, are focusing on worker classification issues.
Voluntary Classification Settlement Program
On September 21, 2011, the IRS announced a new program, details are provided in, Announcement 2011-64 and IR-2011-95, called the Voluntary Classification Settlement Program (VCSP) that allow employers the opportunity to get back into compliance.
The VCSP is optional and provides taxpayers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past non-employee treatment. The relief is similar to the current Classification Settlement Program (CSP) which is available to taxpayers under IRS examination.
To participate in the program, the taxpayer must meet certain eligibility requirements, apply to participate in VCSP, and enter into a closing agreement with the IRS.
Independent Contractor or Employee
Whether a worker is performing services as an employee or an independent contractor depends upon the facts and circumstances and is generally determined under the common law test of whether the service recipient has the right to direct and control the worker as to how to perform the services.
In some factual situations, the determination of the proper worker classification status under the common law may not be clear. For taxpayers under IRS examination, the current CSP is available to resolve federal employment tax issues related to worker misclassification, if certain criteria are met.
The examination CSP permits the prospective reclassification of workers as employees, with reduced federal employment tax liabilities for past non-employee treatment. The CSP allows business and tax examiners to resolve the worker classification issues as early in the administrative process as possible, thereby reducing taxpayer burden and providing efficiencies for both the taxpayer and the government.
In order to facilitate voluntary resolution, meaning before an IRS audit, of worker classification issues and achieve the resulting benefits of increased tax compliance, the IRS has determined that it would be beneficial to provide taxpayers with a program that allows for voluntary reclassification of workers outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes.
The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers. The program applies to taxpayers who are currently treating their workers as independent contractors or other nonemployees and want to prospectively treat the workers as employees.
In order to be eligible, the taxpayer:
• Must have consistently treated the workers as nonemployees and filed all required Forms 1099 for the previous three years;
• Cannot be under audit by the IRS, Department of Labor or NJ; and
• Must have complied with the results of a previous audit by the IRS or the Department of Labor concerning worker classification.
Effect of VCSP
A taxpayer who participates in the VCSP will agree to prospectively treat the class of workers as employees for future tax periods. In exchange, the taxpayer will:
1. Pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year as determined under reduced rates;
2. Avoid liability for any interest and penalties on such amount; and
3. Avoid any employment tax audit with respect to the classification of the workers for prior years.
Additionally, a taxpayer participating in the VCSP will agree to 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 taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.
Is VCSP right for my business?
VCSP may be a viable option, but can also be an unnecessary cost for a business that does not have exposure. A tax attorney can help you determine if VCSP makes sense. Additionally, we can help mitigate risks where your company’s employment practices are questionable or help you fight an IRS or New Jersey audit.
The IRS retains discretion whether to accept a taxpayer’s application for the VCSP. Taxpayers whose application has been accepted 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.
If you have any questions how going into the VCSP program may impact your business, please contact us.