Hot on the heels of an announcement that the Internal Revenue Service and the Department of Labor (along with several states, including Massachusetts) have teamed up to work together to address employee misclassification issues, the IRS has announced a new voluntary classification settlement program. Under the new program, employers who have not been properly classifying workers as employees are able to come into compliance through payment of 10% of the employment tax liability that was due for the misclassified workers for the most recent tax year.
Eligibility. In order to qualify for the program, an employer must have consistently treated the workers as non-employees and must have filed all required Forms 1099 for the past three years. The employer also cannot be under an IRS audit (apparently of any kind) or a Department of Labor or state agency audit relating to worker classification. (By the way, “employer” for this purpose includes tax exempt organizations and state and local governments.)
An employer may elect to reclassify some or all workers, although all current and future workers in a particular job category must be similarly reclassified.
Terms and Conditions. An employer may file an application under this new program using IRS Form 8952. The application needs to be filed at least 60 days before the date on which the classification will change. The IRS will notify the employer if the application is accepted. In that case:
- The employer will need to pay 10% of the employment tax liability due for the most recent tax year. The employment tax liability is calculated by adding 10.68% (for 2010; 10.28% for 2011) of compensation up to the $106,800 (for both 2010 and 2011) Social Security wage base and 3.24% of compensation in excess of the Social Security wage base;
- The employer will not be liable for interest or penalties, and will not be subject to an employment tax audit for prior years with respect to workers reclassified under the program; and
- The employer and the IRS must enter into a closing agreement. The closing agreement includes an agreement to extend the statute of limitations on the assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the employer agrees to begin treating the workers as employees.
Benefits Implications. While this new program provides an excellent opportunity for employers to clean up potential misclassification issues, an employer must also understand the collateral implications of participating in the program. A reclassified worker may, for example, suddenly become eligible for one or more benefits plans. And in a state like Massachusetts, which includes a statute that aggressively reclassifies workers who may truly be independent contractors under conventional common law tests, the possibility of reclassification of a worker under this program may give rise to claims for damages by the worker concerning past practices.
What’s an Employer to Do? Leaving the Massachusetts statute aside for the moment, an employer should not feel compelled to reclassify workers who truly meet the IRS’s current definition of “independent contractor.” That said, the bias toward employee classification is clear and the quest for revenue has federal and state governments looking at various ways to ensure that workers are “correctly” classified as employees. Federal interagency agreements and agreements to share information with the states on this topic are proliferating.
In Massachusetts, the stakes are even higher, since violation of state law can mean mandatory treble damages, even in the case of an unintentional violation.
What to do in any particular situation requires careful analysis. But the advent of this new voluntary settlement program provides yet one more good reason for employers to take a more proactive approach in addressing the worker classification issue.