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Should Your Company Take Advantage of the New IRS Voluntary Worker Classification Settlement Program? Look Before You Take A Leap!

October 2011

By: Nancy E. Joerg, Esq.

On September 21, 2011, the Internal Revenue Service (IRS) kicked off its brand new Voluntary Worker Classification Settlement Program (VCSP). Under this revolutionary program, eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past if they voluntarily reclassify their workers who currently receive 1099s.

The IRS states that this new program will allow employers "the opportunity to get into compliance" by making a minimal payment covering past payroll tax obligations, rather than waiting for a possible future IRS audit.

ELIGIBILITY REQUIREMENTS:

To be eligible for the VCSP, an applicant company must:

  • Consistently have treated the workers (i.e., independent contractors) in the past as nonemployees
  • Have filed all required Forms 1099 for the workers (i.e., independent contractors) for the previous three years
  • Not currently be under audit by the IRS
  • Not currently be under audit by the Department of Labor or a state agency concerning the classification of these workers (i.e., independent contractors)

    Also, a taxpayer company who was previously audited by the IRS (or the Department of Labor) concerning the classification of the workers will only be eligible for the VCSP if the taxpayer has complied with the results of that audit.

    WHAT THE TAXPAYER COMPANY RECEIVES: A taxpayer company who participates in the VCSP will agree to prospectively treat the class of workers as employees for future tax periods. In exchange, the taxpayer company will pay 10% of the employment tax liability that may have been due on compensation paid to the misclassified independent contractors for the most recent year and will not be liable for any interest or penalties on the liability (and will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years).

    CATEGORIES OF WORKERS: Some companies use many different categories of independent contractors. For example, a construction company may have categories of independent contractors including: drywallers, carpenters, painters, cement workers, door and window installers, etc. Companies may wonder whether they can enter into the VCSP for just one category of worker-the door and window installers, for example. The answer is yes. As a matter of fact, a company must agree when they enter into the Closing Agreement with the IRS under the VCSP that they will make all independent contractors in a certain category employees, such as all door and window installers, but the company does not have to agree to reclassify all different categories of independent contractors to employees under the VCSP.

    POTENTIAL PITFALLS: If a taxpayer company voluntarily reclassifies its independent contractors as employees, the company will likely be required to undergo costly changes such as adding workers compensation coverage, withholding income tax payments and taking Medicare and Social Security deductions from wages. Also, the company must agree to extend the statute of limitations period on assessment of employment taxes by the IRS for three years - for the first, second, and third calendar years beginning after the date on which the taxpayer company has agreed under the VCSP Closing Agreement to begin treating the workers as employees.

    Other unresolved issues may be liability concerning past overtime and other wage and hour violations, past employee benefits, etc. A lot to consider!

    One big problem that I see is that once a company reclassifies its independent contractors to employee status, the possibility of using a Section 530/Safe Haven/Safe Harbor defense in the future will be lost forever as to that category of independent contractor. The VCSP would essentially require employers to forgo protections offered under Section 530. Employers with strong positions under Section 530 should be aware of what they are giving up!

    You may wonder why a company would need to use a Section 530 defense in the future if they are no longer using independent contractors. The simple answer is that the company may decide in the future that it wants to go back to an independent contractor model after having tried the employee model for several years. If the company decides to go back to an independent contractor model, the company would no longer have the opportunity to use a Section 530 defense (because now they do not have consistent use of independent contractors which is a strict requirement of the Section 530/Safe Haven/Safe Harbor defense).

    FORM 8952 - APPLICATION FOR VOLUNTARY CLASSIFICATION SETTLEMENT PROGRAM: There is an application online for acceptance into this VCSP program and interested companies might do well to review the two page application. It is interesting to read and see what a company must agree to and what information a company must give under penalty of perjury.

    Of course, just filling out an application to be accepted into the VCSP does not guarantee that a taxpayer company will be found eligible to enter the VCSP. One of the unanswered questions is - If a company is found to be ineligible for VCSP, could the information they have placed on the application be used by the IRS for audit leads? We know, for example, that when companies send in the IRS Form SS-8 to the IRS for an opinion on whether the worker is an independent contractor or an employee, the IRS occasionally uses the submitted IRS Form SS-8 form as a lead for an IRS audit of that company. Dirty pool?

    The bottom line is that any company considering applying for the VCSP should think it over very carefully with an attorney who is exceptionally well versed in the independent contractor issue. This is not a step to be taken in a light hearted fashion. Currently the VCSP has no deadline or expiration date.

    Questions or concerns? Call Attorney Nancy E. Joerg of Wessels Sherman's St. Charles, Illinois office: 630-377-1554 or email her at najoerg@wesselssherman.com.