Determining proper classification of workers, either as independent contractors or employees, can be a subjective challenge for employers. The determination of whether a worker is an employee or an independent contractor is based on the facts and circumstances surrounding the individual’s work for the employer. Generally, the more the employer is able to control and direct the worker, the more likely the worker should be classified as an employee. Furthermore, employment taxes are a significant source of federal revenue, so taxpayers face heavy scrutiny.
Worker classification issues uncovered in an audit can lead to costly assessments of past employment taxes, penalties, and interest for reclassified employees. Nontax exposure, such as reclassified workers’ benefit provisions, may also exist. Representatives and practitioners serving taxpayers at risk for worker reclassification should carefully consider the alternatives available to assist taxpayers in becoming compliant. One alternative is the Voluntary Classification Settlement Program (VCSP).
Generous Relief From Liability
Before the VCSP was established, only taxpayers under audit could resolve worker classification issues and obtain relief from federal employment taxes through the IRS’s Classification Settlement Program (CSP). The IRS established the VCSP to allow taxpayers to come into compliance prospectively while obtaining generous relief from liability for past federal employment taxes. In exchange for voluntary compliance and reclassification of workers as employees, the taxpayer receives the following relief:
- The taxpayer pays 10% of the employment tax liability that would have been due on compensation paid to the workers being reclassified for the most recent tax year (determined under the reduced rates of Sec. 3509(a));
- The taxpayer is not liable for any interest and penalties on the liability; and
- The taxpayer is not subject to an employment tax audit of the worker classification of the class or classes of workers for prior years.
To participate in the program, a taxpayer must meet eligibility requirements spelled out in Announcement 2012-45, which modified the prior rules, to permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate in the VCSP. In addition, Announcement 2012-45 eliminated the earlier requirement that a taxpayer agree to extend the period of limitation on assessment of employment taxes as part of the VCSP closing agreement. These modifications favor the taxpayer and further encourage participation in the VCSP.
To participate in the VCSP, eligible taxpayers must apply by filing Form 8952, Application for Voluntary Classification Settlement Program.
Considering the favorable relief available under the VCSP, taxpayers at risk for worker reclassification should consider the benefits of applying for and participating in the program. Participating in the program not only provides relief from penalties, but also provides taxpayers with a higher level of certainty about the proper classification of their workers.
A word of caution is in order, though. Most states do not coordinate with the IRS’s VCSP. As such, state tax treatment of taxpayers that participate in the federal program is uncertain.
For a detailed discussion of the issues in this area, see “Options for Compliance With Worker Classification Rules,” by Amy Lehmkuhl, CPA, in the July 2013 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also look for articles on the following topics in the July 2013 issue of The Tax Adviser:
- A look at the IRS’s first-time penalty abatement program.
- A discussion of targeted partnership allocations.
- An analysis of what to do about erroneous tax return positions.