Over the last few years, the issue of employers misclassifying employees as independent contractors has been a top enforcement priority for both the U.S. Department of Labor and the Internal Revenue Service. Recently, the DOL and the IRS entered into an agreement to coordinate their efforts on employee misclassification compliance, which will include more sharing of information between the two agencies and stepped-up enforcement. At the same time, the IRS announced the development of a new program that permits employers to avoid retroactive employment tax liability by voluntarily reclassifying classes or groups of independent contractors and other workers as employees for federal employment tax purposes. The program is called the Voluntary Classification Settlement Program (“VCSP”) and is described in IRS Announcement 2011-64. Businesses that regularly engage the services of individuals as independent contractors whose status may be questionable should consider the potential benefits — and risks — of the new program.
Organizations that agree to prospectively reclassify groups or classes of workers from independent contractors to employees can reduce their retroactive employment tax liability to as little as 10 percent of the prior year’s potential tax liability as well as avoid any interest and penalties on the liability. Additionally, participating businesses may not be subject to an employment tax audit with respect to the worker classification for the class or group of workers for prior years. Along with agreeing to prospectively treat the class or group of workers as employees in future tax periods, employers must also agree to extend the period of limitations on assessment of employment taxes for the first three calendar years beginning on the date that the employer agrees to begin treating the workers as employees.
To be eligible for the VCSP, an employer must have consistently treated the class or group of workers as independent contractors and must have filed all required Forms 1099 for the previous three years. The employer cannot be under any type of IRS audit and cannot be under audit concerning worker classification by the DOL or a state governmental agency. Also, if an employer was previously audited concerning the classification of workers, the employer will be eligible only if it complied with the results of the audit.
Interested employers must submit an application at least 60 days prior to the date the employer wishes to begin treating the class or group of workers as employees. Submission of the application does not, however, guarantee that the IRS will accept it. The IRS may reject applications and most likely would do so if the employer does not clearly meet the eligibility guidelines.
Risks and Benefits
Businesses should carefully weigh the potential benefits and risks before applying for this program. First, a business would have to be nearly certain that the worker or class of workers at issue actually is improperly classified before submitting an application. Applying to this program is tantamount to an admission of misclassification.
Second, businesses would need to consider what other liabilities they could face by admitting to the misclassification. The potential liabilities include claims arising during the period of misclassification by workers for unpaid wages (minimum wage, overtime, meal breaks, etc.) under the FLSA or state law; claims for employee benefits, which may have vested or accrued had the individuals been classified as employees; employment law claims (discrimination, FMLA, etc.); and claims by state agencies for unpaid workers' compensation, unemployment insurance, and other payroll taxes. Additionally, businesses will need to weigh the risk that if an application is rejected, they may then be subject to audits by the IRS, DOL or state agencies, as applications are not anonymous nor is acceptance automatic.