Small Business Taxes & ManagementTM--Copyright 2011, A/N Group, Inc.
In late September, the IRS announced a new program (voluntary classification settlement program, VCSP) that may enable employers to resolve past worker classification problems at much less cost than under normal procedures by voluntarily reclassifying the workers. Under the program, a qualifying employer would pay just 10 percent of the normal amounts to cover past payroll obligations than under an IRS audit. The savings from back employment taxes could be substantial. The cost equates to just under 2 percent of the total renumeration paid to the workers, with no interest or penalties. To be eligible, the employer must:
Employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before they want to begin treating the workers as employees.
Participating employers will not be audited on payroll taxes related to these workers for prior years. However, they will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies.
Employee or Independent Contractor?
This has been a contentious issue between the IRS and employers for many years. In the late 70's Congress attempted to mitigate the effects of an IRS reclassification of workers as employees. Without the intervention, an IRS reclassification could prove extremely costly to an employer. That was supposed to be an interim measure. Unfortunately, despite the passage of over 30 years, the issue has not been resolved.
Many issues are clear cut; the worker should have been classified as an employee. For example, you provide the tools, you control when and where the work is to be done, you pay the worker hourly, and reimburse him for any expenses incurred. Under these facts, the worker is almost surely an employee. It doesn't matter how long the individual works for you. For example, you hire a receptionist for four days. It's unlikely the person could be classified as an independent contractor.
But many situations can be difficult to resolve. IRS Publication 15-A gives some insight into how to classify workers.
The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers. The program applies to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to prospectively treat the workers as employees. To be eligible, a taxpayer must have consistently treated the workers as nonemployees, and must have filed all required Forms 1099 for the workers for the previous three years. The taxpayer cannot currently be under audit by the IRS. Furthermore, the taxpayer cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency. A taxpayer who was previously audited by the IRS or the Department of Labor concerning the classification of the workers will only be eligible if the taxpayer has complied with the results of that audit.
A taxpayer who participates in the VCSP will agree to prospectively treat the class of workers as employees for future tax periods. In exchange, the taxpayer will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509 of the Code; will not be liable for any interest and 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. Additionally, a taxpayer participating in the VCSP will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.
Here's what you would pay if you filed all Forms 1099 and consistently treated the workers as independent contractors, but did not file for relief under the VCSP:
Tax ----------------------3509 Percentage for----------------------- 2011 compensation 2010 compensation amounts over wage base Federal Income Tax Withholding 1.5 1.5 1.5 Employee Social Security Tax .84 1.24 0 Employer Social Security Tax 6.2 6.2 0 Employee Medicare Tax .29 .29 .29 Employer Medicare Tax 1.45 1.45 1.45 Totals 10.28 10.68 3.24Notes.
The amount due under the VCSP is calculated based on compensation paid in the most recently closed tax year, determined at the time the application is being filed. Thus, the 10.68% rate applies in 2011 since the most recently closed year is 2010 and the 10.28% rate applies in 2012.
For example, in 2010 you paid $965,000 to workers that qualify for the VCSP; all of the workers earned less than the Social Security wage base of $106,800. You submit the VCSP on November 1, 2011 and you want the beginning date of the quarter for which you want to treat the class of workers as employees to be January 1, 2012. Using the 2010 compensation column amount of 10.68% and applying that to the total compensation, under Section 3509 the employment taxes would normally be $103,062. Under the VCSP, your payment would be only 10% of this amount or $10,306, a saving of $92,756.
Not all workers have to be reclassified, but all workers in the same class must be treated as employees. For example, you own a nursery. You employ retail sales people in the shop; clerical staff in the office; day workers work in the greenhouses and the fields; deliverymen; and workers who do lawn maintenance for customers using the company's equipment. You currently treat the sales and clerical staff as employees; the others as independent contractors. You can reclassify just the individuals who work in the greenhouses and fields as a class. Once you do so you must treat all workers in that class as employees.
You don't submit any money with the application. You must wait until the IRS accepts you into the VCSP. You include payment with the VCSP closing agreement with the IRS. The IRS will also contact you if your application is not accepted.
Should You Apply?
The VCSP offer is extremely attractive. If you're audited and the IRS reclassifies your workers, you'll be liable for far more. And this amnesty could be a prelude to stricter enforcement of the rules with respect to worker classification. That means a better chances of getting caught in the future.
The first step is to determine if the workers should be classified as employees. You may need professional help here. Your CPA or other tax advisor may be able to determine the worker's status based on IRS material, cases, etc. You should ask your advisor if you should file an SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS. The form asks a number of questions the IRS will use to determine whether the individual is an employee or independent contractor. If the IRS determines the individual to be an independent contractor and you answered the questions carefully and there's no change in the future, you should be able to avoid any taxes and penalties if they reclassify the worker on audit.
If it appears the worker is really an employee, you should submit an application to the VCSP. Keep in mind that you'll be liable for full employment taxes and responsible for withholding taxes going forward. The workers will also be employees for state purposes. That will mean you'll have to cover them for workers' compensation, pay unemployment taxes, etc.
You should be aware that a number of states have their own compliance programs with respect to worker classification. Penalties here can be substantial if a worker has not been covered for workers' compensation. In some cases state rules can be stricter rules those of the IRS.
For more information see Announcement 2011-64, and Form 8952 and the related instructions.
Copyright 2011 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Articles in this publication are not intended to be used, and cannot be used, for the purpose of avoiding accuracy-related penalties that may be imposed on a taxpayer. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 10/19/11