On September 21, 2011, the IRS announced a surprise break for businesses that have been improperly designating their employees as independent contractors. The new program, Voluntary Classification Settlement Program (“VCSP”), enables those businesses to reclassify workers and make only a small payment to cover past payroll taxes. At issue is whether a worker is deemed an employee or an independent contractor. The proper classification depends on several factors including how much direction or control a company has over its workers. The IRS announcement came two days after officials from the Department of Labor, IRS and 11 states proclaimed an agreement to work together to curb the practice of misclassifying employees. Recently, several states have passed laws to regulate misclassification of employees.

The VCSP is part of the IRS’s “Fresh Start” initiative to help businesses address tax issues. The VCSP is designed to increase payroll tax compliance by offering businesses the opportunity to reclassify their workers before any audit occurs. Under the VCSP, companies deemed to be qualified by the IRS will owe approximately one percent of wages paid to reclassified workers in the past year, with no interest or penalties due. The employers will not be audited on payroll taxes for the reclassified workers for prior years. For the first three years of the program, participating employers will be subject to a six-year statute of limitations, rather than the three-year limitation, for payroll tax issues.

To be eligible for the program, the business must:

  1. Consistently have treated workers in the past as nonemployees;
  2. Have filed all required 1099s for those workers for the previous three-year period; and
  3. Not currently be under audit by the IRS, Department of Labor, or a state agency regarding the classification of those workers.

Employers can apply for the program by filing Form 8952 at least 60 days before they wish to begin treating the workers as employees, and the IRS will then determine whether or not the business qualifies.