As part of its effort to provide a "Fresh Start" to taxpayers and businesses, the IRS created the Voluntary Classification Settlement Program (VCSP) to allow employers to voluntarily reclassify their workers (or a class/group of workers) as employees for future tax periods.
Many employers erroneously miss-classify their workers as independent contractors or non-employees. Whether a worker is actually an employee or an independent contractor depends on the facts and circumstances involved. Nevertheless, the classification issue is most often resolved based on whether the employer has the right to direct and control the worker as to how to perform the services. There are many situations where correct classification is unclear.
If the employer is audited and the independent contractors or non-employees are reclassified as employees, the employer will face a substantial tax liability, including interest and penalties, for three years of employment taxes. The VCSP allows employers to avoid this possibility by giving them the chance to preemptively reclassify workers. The VCSP builds on the Classification Settlement Program (CSP) that has already been in place for years. The CSP is available to employers already under IRS examination and allows prospective reclassification of workers as employees with reduced federal employment tax liabilities for past non-employment treatment. The VCSP, on the other hand, allows taxpayers to reclassify without first going through the burden of an examination.
The employer does not have to reclassify all workers in order to be eligible under the VCSP. Nevertheless, if specific workers are reclassified as employees, all workers in the same class must also be treated as employees.
In order to be eligible to participate in the VCSP, the employer:
- Must have consistently treated the workers or a class/group of workers in the past as independent contractors or non-employees
- Must have filed all required 1099s for the workers for the previous three years. These 1099s must have been filed within 6 months of their due dates (including extension) to qualify as having been filed.
- Must not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers. If the employer has previously been audited regarding the classification of the workers, the employer must have complied with the results of the audit in order to be eligible.
In order to participate in this program, Form 8952 must be filed at least 60 days before the employer wants to being treating the workers as employees. The taxpayer should also provide the name of a contact person or authorized representative with a valid Power of Attorney. The IRS will contact this person in order to complete the VCSP process.
If the employer is accepted into the VCSP, the employer will enter into a closing agreement with the IRS to finalize the terms of the agreement and make full payment of the amount due.
If accepted into the program, 10% of the employment tax liability that would have been due on compensation paid to the worker (or class/group of workers) for the most recent tax year must be paid. This amount is determined under the reduced rates of section 3509(a) of the IRC. Interest and penalties will not be assessed and the employer will not be audited on payroll taxes with regards to these workers for past years.
Under section 3509(a), the tax rate for compensation up to the Social Security wage base is 10.28% in 2011 and 3.14% for compensation above the Social Security wage base. Currently, the most recently closed tax year is 2011 so the 10.28% rate applies.
For example: if in 2011 an employer paid $100,000 to workers that the employer wishes to reclassify under the VCSP, the employment taxes applicable to the $100,000 would be $10,280. 10% of this amount is $1,028. (In this example all workers were compensated below the Social Security wage base).
The employer must also agree to be subject to a special six-year statute of limitations (rather than the usual three years) for the first three years under the program.
The IRS promises not to share information about an employer's participation in the VCSP with the Department of Labor or with any state agencies. Furthermore, the IRS states that a rejection of the form 8952 will not automatically trigger a Federal audit.