Act Fast: Expanded Voluntary Worker Reclassification Program Ends June 30
The temporary extension of the Voluntary Classification Settlement Program (VCSP) that permits employers to re-classify workers as employees when the employer did not file Forms 1099 for the previous three years is slated to end on June 30, 2013. Quick action is needed if you want to benefit from the reduced penalties and protection from audit that are are offered by the program.
The regular Voluntary Classification Settlement Program (VCSP) does not expire on June 30, 2013. The VCSP remains available for employers who have regularly filed Forms 1099 for workers that they are seeking to reclassify. The Classification Settlement Program for employers who are involved in an audit also continues to be available.
Why Misclassify Workers?
At first glance, classifying employees as independent contractors seems to be an excellent way to reduce both paperwork hassles and out-of-pocket costs for tax payments. After all, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on the wages that you pay to your employees. You are spared all of these obligations if the person doing the work is an independent contractor.
Unfortunately, in tax law, as in much of life, the easiest option in not necessarily the wisest one. The IRS takes a very dim view of the misclassification of employees as independent contractors. In fact, tracking down employers who misclassify workers is a high priority for the IRS, as indicated by their collaboration with the Department of Labor and numerous states. (See our article, Employee or Independent Contractor? Feds and States Join Forces to Fight Worker Misclassification for additional information about these programs.
Leaving aside the disruption and unpleasantness associated with an extensive IRS audit, you risk owing more in taxes than you would have owed had you correctly classified your workers. If you classify an employee as an independent contractor without a reasonable basis for doing so, you may find yourself paying a portion of the employee's Social Security taxes and a portion of the income tax withholding on their wages, as well as your own portion of Social Security taxes.
If you can control what the worker does and how it will be done, and not simply the result to be accomplished, then it is likely the worker is an employee. Over the years, 20 factors have been developed that help analyze whether the worker is an employee or independent contractor. See our discussion, Is Your Worker an Employee or Independent Contractor for Payroll Tax Purposes?, for more information.
Why Voluntarily Re-classify Your Workers?
Despite its aggressive enforcement actions, the IRS also seems to be aware of the old bromide: "You can catch more flies with honey than with vinegar." So the agency put into place a Voluntary Classification Settlement Program (VCSP) and then temporarily expanded it to enable more employers to participate.
The Voluntary Classification Settlement Program Temporary Eligibility Extension (VCSP TEE) opened the program to employers who failed to file the Forms 1099 that should have been filed for all independent contractors. With the exception of the form filing requirement, the eligibility requirements for the two programs are identical. The penalty amount that must be paid is higher under the VCSP TEE (25 percent) than under the regular VCSP (10 percent) in recognition of the greater culpability involved in failing to comply with the information reporting, Form 1099, requirements.
Employers receive several benefits from proactively applying for voluntary reclassification. One of the biggest benefits is peace of mind. Employers who participate in the voluntary reclassification program will not be audited on payroll taxes related to these workers for prior years. In the words of former IRS Commissioner Doug Shulman when he announced the program: “This settlement program provides certainty and relief to employers in an important area.”
As Shulman noted, another important benefit is "monetary relief." You will save a considerable amount of money if you voluntarily reclassify, rather than waiting for the IRS to ferret you out and reclassify your workers following an audit.
Under the temporary extension of the voluntary program, you will only owe 25 percent of the employment tax liability due on compensation paid to the workers for the most recent tax year, determined under the rules that apply to reclassifications. (The amount owed under the regular VCSP is 10 percent.)
You own a construction company. The workers' total compensation for 2012 was $500,000 and none of the compensation exceeded the Social Security wage base. Even if you qualify for reduced liability, you will owe $53,400 (10.68 percent of $500,000) for 2012 wages. You will owe a similar amount for previous years for which the workers were misclassifed.
Assume the same facts as above, but you apply to participate in the Voluntary Classification Settlement Program Temporary Eligibility Expansion. Under this program, the maximum amount you will owe is $13,350 :25 percent of the most recent year's applicable employment taxes.
If you had filed Forms 1099 for these workers for each of the past three years, you would be able to apply under the regular VCSP program. This would further lower your tax liability to only $5,340, only 10 percent of the amount you would otherwise owe.
If a 75 percent (or 90 percent) tax savings isn't enough to pique your interest, you also will be spared any interest and penalties on the liability. Under the VCSP TEE, you will, however, have to pay a reduced penalty related to any unfiled Forms 1099.
Your tax issues could be even worse if you are considered a person who is responsible for withholding and paying over taxes (and nearly every small business owner is going to be a responsible party). You could be held personally liable for the amount of tax that should have been paid over to the IRS, in addition to owing the worker's portion of employment taxes and income tax withholding.
Who Can Participate in the Temporary Program?
You can participate in the VCSP TEE program if you meet these requirements:
- You must apply on or before July 1, 2013. (The program closes on June 30, but because that is a Sunday, the deadline moves to Monday.)
- You must have consistently treated the workers as nonemployees.
- You must not be under audit currently by the IRS, the Department of Labor or a state agency concerning the classification of these workers.
- Once your application is accepted, you must electronically file (and pay the reduced failure to file penalty) Forms 1099 for all reclassified employees for all open tax years.
- You must enter into a closing agreement with the IRS that finalizes all the terms of the agreement.
You apply by filing Form 8952, Application for Voluntary Classification Settlement Program, which is the form used for the standard VCSP. However, you should make the following changes:
- Write "VCSP Temporary Eligibility Expansion" on the top of Form 8952.
- Put a line through Line 3A in Part V (which relates to filing Forms 1099)
- Leave Part IV, Payment Calculation, blank.
- Complete the worksheet that the IRS provided in Announcement 2012-46 to determine the payment amount
- Attach the completed worksheet to Form 8952.