Whether a business should treat a particular worker as an
employee or an independent contractor has been a longstanding
source of contention between the business community and the
Internal Revenue Service. Generally, business owners recognize that
the tax and regulatory requirements are less onerous when they
treat their workers as independent contractors rather than
employees.
Therefore, the incentive for many is to find a way to treat their
workers as independent contractors. Because worker classification
is based on the facts and circumstances of each case, attempts by
the IRS -- as well as state tax and unemployment authorities -- to
reclassify workers have often led to litigation. By 1978, Congress
offered a safe harbor for businesses that misclassified employees
as independent contractors. The safe harbor has since led to its
own body of case law. In light of these developments, the issue of
worker misclassification remains.
On Sept. 21, the IRS launched a Voluntary Classification
Settlement Program (VCSP), a program designed to provide employers
an opportunity to reclassify workers as employees for employment
tax purposes. The VCSP allows eligible employers to obtain relief
similar to that offered under the Classification Settlement Program
(CSP) for employers under examination. Under the VCSP, employers
not under examination may voluntarily reclassify their workers as
employees for future tax periods, with limited tax liability for
past nonemployee treatment of workers.
To qualify for the VCSP, employers must meet eligibility
requirements, they must apply through the VCSP, and they must enter
into a closing agreement with the IRS.
According to the IRS, the program is designed to increase tax
compliance by employers and reduce their burden by providing
greater certainty for them, for their workers and for the
government. Commissioner Doug Shulman described the program as part
of a wider effort to help give employers a fresh start with their
tax obligations. The program is open to many businesses, tax-exempt
organizations and government entities that currently treat their
workers, or a class or group of their workers, erroneously as
independent contractors or nonemployees and want to prospectively
treat the workers as employees.
To qualify for the program, employers must meet the following
eligibility requirements:
- They must want to reclassify voluntarily certain workers as
employees for federal income tax withholding, FICA and federal
unemployment taxes for future periods;
- They must presently be treating workers as nonemployees;
- They must have complied with any Form 1099 filing requirements
for the past three calendar years with respect to the workers they
seek to reclassify as employees. Employers will satisfy this
requirement if they provided Forms 1099 to workers for the entire
time they worked for the employer if they worked for the employer
less than three years;
- They must have treated the workers consistently as
nonemployees;
- They must not currently have a dispute with the IRS over
whether the workers are employees or nonemployees for federal
employment tax purposes;
- They currently must not be under examination by the IRS;
- They must not be under examination by the Department of Labor
or any state agency for the proper classification of the workers;
and
- They either must not have been subject to a prior IRS or
Department of Labor examination for the classification of workers,
or if they have been examined previously, they must have complied
with the results of the prior examination.
Employers interested in reclassifying their workers as employees
under the program can apply by filing Form 8952: Application for
Voluntary Classification Settlement Program.
Those employers who are accepted into the program will be required
to pay 10 percent 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 Internal Revenue
Code Section 3509. They will not face interest or penalties, and
they will not be subject to an audit for payroll taxes related to
the reclassified workers for prior years.
Additionally, an employer must agree to extend the period of
limitations on assessment of employment taxes for the first three
years after the date the employer elects to begin treating the
workers as employees under the VCSP closing ?agreement.
When asked about his expectations regarding the popularity of the
program, Commissioner Shulman stated that it is unclear how many
employers may enter the program, or how much revenue it will
generate. He did state, however, that the IRS will maintain a
"robust audit program" to pursue employers who intentionally
sidestep the law.
Should an employer forego the program and later face an employment
tax audit, the IRS will review the business-worker relationship by
focusing on whether the business has the legal right to control
what work is done and how it is to be done by its worker. In
addition, the IRS will consider the 20-factor test from Revenue
Ruling 87-41.
If an audit results in a change in the status of workers from
nonemployees to employees, the result may be additional tax,
penalties and interest for prior years of worker misclassification.
The potential exposure could be substantial, even for small
businesses.
Even when not the subject of an audit, a business or a worker may
complete a Form SS-8: Determination of Worker Status for Purposes
of Federal Employment Taxes and Income Tax Withholding, to seek a
determination by the IRS of the business' or the worker's
individual circumstances.
When asked whether the Massachusetts Department of Revenue has
plans to issue its own classification amnesty program to accompany
the VCSP, a DOR spokesman stated that the DOR conducted a similar
amnesty in the past, but few employers came forward. The spokesman
said that the DOR is not currently working to issue a directive.
n
Christopher G. Beck is an associate attorney at Vacovec, Mayotte
& Singer LLP in Newton, a firm concentrating in tax law. Beck
focuses his practice on domestic and international tax planning,
compliance and controversy.