Worker Classification: The New ‘Get Out of Audit Jail Free’ Card!

By Larry Rubin

In recent years, the battle over how workers are classified has heated up.  Federal and state government agencies have been going after businesses that intentionally or unintentionally classify their workers inaccurately as independent contractors when they should have been classified as employees.  The resulting audits have proven to be very costly for companies that aren’t in compliance.

In a surprising move, the IRS recently announced the Voluntary Classification Settlement Program (VCSP), which will enable employers to address their worker classification noncompliance issues and resolve them with certainty at a relatively low tax cost.  The VCSP does not add any clarity to existing laws, but rather provides a mechanism for employers to reclassify its workers prospectively without incurring substantial costs and without being subject to an audit.

To be eligible, an employer must meet these three criteria:

1. The employer has treated all workers consistently – the individual has never been classified as an employee, and workers who hold a substantially similar position have also never been classified employees.
2. The employer has filed a Form 1099 for each misclassified worker for each of the past three years.
3. The employer cannot be presently under examination by the IRS for any reason, and is not presently under examination by the Department of Labor or any state government agency with respect to the worker classification issue.

To be part of the VCSP, the employer must fill out Form 8952 (Application for Voluntary Classification Settlement Program) at least 60 days prior to the date the employer wants to begin to reclassify the workers as employees.  The IRS will then review the employer’s eligibility, and contact the employer to complete the process and enter into a closing agreement.

If accepted into the VCSP, the employer will then:

• prospectively treat the subject workers as employees;
• pay 10% of the employment tax liability that would have been due for the previous year as computed under Code Section 3509;
• not be liable for interest or penalties;
• not be subject to a federal employment tax audit for prior years on the classification of these workers; and
• agree to extend the employment tax statute of limitations from 3 years to 6 years for each of the first three calendar years beginning after the VCSP closing agreement.

Further information can be found on the IRS’ FAQ page, and we strongly advise you to contact your Aronson tax advisor at 301.231.6200 to help avoid the potentially costly consequences of trying to handle this matter on your own.