Employers and the IRS often disagree as to whether workers should be treated as independent contractors or employees. Employers tend to favor the simplicity of not withholding wages and not paying payroll taxes, while the IRS favors tax collection via withholding. Whether a worker is properly classified as an independent contractor or an employee is determined under a facts-and-circumstances test that centers on the employer’s ability to control and direct the worker on a day-to-day basis. The IRS recently introduced a new settlement program that allows eligible taxpayers who have treated workers as independent contractors to prospectively reclassify these workers as employees, with minimal consequences.
To be eligible for this new program, a taxpayer:
- must have consistently treated the workers as independent contractors in the past;
- must have filed all required Form 1099s for the workers for the previous three years; and,
- cannot be currently under audit by the IRS, the Department of Labor or a state.
If the IRS or Department of Labor previously has audited the taxpayer concerning the classification of the workers, the taxpayer will only be eligible if it has complied with the results of that audit.
If accepted into the program, the taxpayer must agree to prospectively treat the reclassified workers as employees for all future tax periods. In exchange, the IRS will assess employment taxes on only one year’s wages, rather than on all periods with an open statute of limitations, and at a tax rate of approximately 1.1 percent, rather than at the special rate used in employment tax audits of approximately 11 percent. Further, the IRS will waive interest and penalties, and will not challenge the classification of the workers for any prior years.
To participate in the voluntary classification settlement program, an eligible taxpayer must apply by completing Form 8952 (Application for Voluntary Classification Settlement Program) and, after accepted, enter into a closing agreement with the IRS. The program also is available to exempt organizations and government entities, if eligible under the requirements discussed above.
Taxpayers should be aware that amnesty offers are typically followed by enhanced scrutiny and enforcement.