IRS Offers Amnesty Program

Recent surveys and studies suggest that an estimated 10% to 30% of employers misclassify their employees as independent contractors.  This sometimes happens because employers are unsure how to classify workers under the Internal Revenue Service (“IRS”) Code’s complicated multi-factor test.  Unfortunately, misclassification can have significant financial consequences for businesses that are audited.  At stake are potentially substantial amounts of back withholding, penalties, and interest, all calculated based on what a business should have paid to the federal government had a worker been properly classified as an employee rather than an independent contractor.

On September 19, 2011, the Department of Labor (“DOL”) and the IRS announced an effort to coordinate with each other and with state agencies regarding employers’ misclassification of employees as independent contractors.  Given the ever-increasing number of audits being conducted by the DOL, this has potentially serious ramifications for employers.  If, for instance, the DOL determines that an independent contractor is misclassified, the DOL now may share that determination and supporting evidence with the Arizona Department of Economic Security, the Arizona Industrial Commission, or other State agencies, which could very well lead to additional investigations, fines, and liability beyond that imposed by the DOL or the IRS.

On September 21, 2011, within days after cautioning employers about the collaborative enforcement efforts, the IRS announced a new voluntary program to allow employers to reclassify, for employment tax purposes, workers who have been improperly classified as independent contractors.  In general, the program allows employers to eliminate years of past tax liability for a one-time payment of only one percent of the wages paid to the reclassified workers for the past year.  This sum is far less than what a typical employer would pay following an audit determination by the IRS that the employer had misclassified employees as independent contractors.  To participate in this program, the employer must be outside of an IRS examination, meet certain eligibility requirements, apply to participate in the program, and enter into a closing agreement with the IRS.

The almost simultaneous announcements about planned enforcement efforts on the one hand and the new amnesty program on the other hand do not appear to be coincidental.  The DOL and the IRS are encouraging businesses to resolve their misclassification violations informally by making clear what the consequences will be if those errors are left unchecked.

Given these developments, employers should consult with counsel at the earliest opportunity to review the duties and responsibilities of workers who currently are classified as independent contractors.  If this review reveals workers who should be reclassified as employees, the IRS’s voluntary program may provide a mechanism to remedy the situation more efficiently and economically compared to the consequences usually encountered in an audit process.