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IRS Settlement Program - Independent Contractors vs. Employees

Introduction
Employers who determine that they are misclassifying workers as independent contractors should take advantage of a new IRS Voluntary Classification Settlement Program (the "VCSP").

The Basics
In essence, VCSP prospectively treats workers as employees instead of independent contractors at a cost of approximately 1% of the compensation paid to the workers reclassified during the most recent tax year.

Example: Company paid $100,000 to four independent contractors during tax year 2011. If the Company applies for VCSP, it pays a penalty of about $1,000 and agrees to classify the workers as employees from tax year 2012 forward.

Eligibility
To participate in VCSP, the company:

    1. must have consistently treated the workers as nonemployees;

    2. must agree to treat all workers in the same class as employees;

    3. must have filed all required Forms 1099 for the workers for the previous three years;

    4. cannot currently be under audit by the IRS; and

    5. cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.

Consequences
As stated above, the penalty will amount to about 1% of the amount paid to the reclassified workers, but no interest or additional penalties will be asserted and the company will not be audited on the issue for prior years.

The statute of limitations for assessment is extended to six years for the first three years under the program.

Procedure
To participate in VSCP a company:

(i) must submit an application to IRS which must be approved;

(ii) sign a closing agreement documenting the reclassification; and

(iii) pay the penalty when the closing agreement is signed.

Evidently, there is no deadline for participation.

Conclusion
Companies with questionable worker classifications should strongly consider VCSP as a cost-effective way to avoid potentially huge taxes and penalties.