The IRS wants employers to get to know their employees, if they do not know them already, and the agency has two effective tools to help them do that. The first tool, audit and enforcement, has been used for a long time; it is well-worn, and many would say the IRS is proficient in its use. The second tool, the Voluntary Classification Settlement Program (VCSP), is a bit newer, but many employers are finding it effective and preferable to the traditional audit tool. Both tools are designed to achieve worker classification that discloses a taxpayer’s employees.
The IRS readily will use either tool. One might ask New York sole proprietor-contractor Mieczyslaw Kurek about the audit tool. He is just one of the latest of many taxpayers to face audits and learn who the IRS believes are their employees. At the end of last month, the U.S. Tax Court upheld the IRS’s determination that this small business, which was served by approximately 10 to 20 workers at a time, was liable for federal employment taxes (FICA, withholding, and FUTA) totaling nearly $40,000 for a single tax year. See Kurek v. Comm’r of Internal Rev., Docket No. 5459-11 (U.S. Tax Ct. Feb. 28, 2013), which may be accessed here.
The Kurek case was a worker classification case and represents a story that has been told many times over. In the course of an audit, the IRS reclassifies workers treated by a taxpayer as independent contractors to employees. The determination is highly fact-sensitive, requiring consideration of several common law factors tending to show the degree of direction and control exercised by the taxpayer with respect to the workers. More direction and control makes it more likely that the IRS will determine the workers to be employees, and determinations of employment tax deficiencies will follow.
Taxpayers at risk of having workers reclassified as employees might rather see the other tool be put to use, one that requires request by the taxpayer and approval by the IRS before it can be used. The VCSP first was launched in IRS Announcement 2011-64 (Oct. 11, 2011). The program permitted taxpayers to voluntarily reclassify workers as employees and treat them prospectively as such. In exchange for that promise, the taxpayer-employer would have to pay only 10% of the employment tax liability that would have been due on the reclassified workers in the preceding year, without interest and penalty and with the IRS promising not to audit the taxpayer for worker classification regarding the reclassified employees for past years. The taxpayer also would have to agree to a longer statute of limitations for employment taxes for the first three tax years following entry into the program.
The IRS modified the VCSP in Announcement 2012-45 (Dec. 17, 2012) to permit taxpayers currently under audit (other than an employment tax audit) to be eligible for the program and to eliminate the extension of the limitations period for participants in the program. Then, in Announcement 2012-46 (Dec. 17, 2012), the IRS introduced the VCSP Temporary Eligibility Expansion.
The Expansion opens up the VCSP to taxpayers that have failed to file required Forms 1099 for the previous three years regarding workers now being reclassified. Taxpayers entering into agreements with the IRS under the Expansion program must then electronically file the missing 1099s as part of their agreements with the IRS and will be subject to reduced penalties for the unfiled 1099s. The Expansion involves payment of 25% of the tax liability that would have been due on compensation for the preceding year, as opposed to the 10% assessment in the original Program. But like the original Program, no interest or penalty will be assessed against that liability and the IRS will not audit the taxpayer for worker classification for past years regarding the disclosed employees.
Application for both the VCSP and the Expansion requires submission of Form 8952. Expansion applicants must write “VCSP Temporary Eligibility Expansion” at the top of the form. Submissions for the Expansion program must be filed on or before June 30, 2013. The IRS has not announced an expiration of the regular VCSP.
There is potentially much more to like about introducing employees to the IRS through VCSP than having the IRS make the introductions by way of audit. However, taxpayers still should consider certain risks before deciding VCSP is for them. For example, the Program involves an agreement only with the IRS, and it does not affect worker classification issues that can arise with other agencies, such as the Department of Labor and state taxing authorities. Also, some taxpayers might seek protections from the Program even when their current classification of workers as nonemployees actually is correct. Still, cases like Kurek are useful reminders that taxpayers should observe how they classify their workers, talk with their tax professionals, and determine whether the rewards of VCSP or even disclosure of employees to other authorities would be prudent.