For many years, employers have been troubled by the proper classification for certain individuals who work somewhat autonomously and are not “traditional” employees. Are they an employee or an independent contractor?  The worker classification rules, developed in the late 1970s, were prior to the days of “telecommuting” or flexible work schedules.  As a result, it is often a challenge to determine the correct classification. Declaring the individual as an independent contractor can save the company significant payroll taxes (FICA, Workers’ Compensation) as well as benefit costs. But misclassifying an employee as an independent contractor can be expensive, as Microsoft discovered when it was sued by individuals for wrongful exclusion from benefit plans.  Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997). Additionally, the IRS may, upon audit, find the company has improperly classified employees and impose significant back payroll taxes, interest and penalties. 

There have been no regulations provided to guide the employer with determining the correct classification of these workers. However, on September 21, 2011, the IRS issued a new “Voluntary Classification Settlement Program” that will allow the employer to present their situation to the IRS for a determination of the proper classification of these workers.  Announcement 2011-64

Under this program, should the workers be determined to be employees rather than independent contractors, the employer’s liability would be 10% of the employment tax liability that may have been due, and no penalty or interest would be assessed. Additionally, the employer would not be subject to an employment tax audit regarding worker classification for prior years.

For many employers, this program may be an attractive answer to the complex problem of worker classification. However, entering into this program may not be the best avenue for many employers. Employers should carefully consider the various ramifications of the program and evaluate the benefits of entering into this program.