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Stephen J. Ehrenberg
Stephen J. Ehrenberg

Expanded voluntary classification settlement program

IRS focuses on worker classification problems, but offers more liberal relief.

March 28, 2013
by Stephen J. Ehrenberg, CPA

The dispute between employers and federal and state taxing authorities over worker classification has been waged for many years. The dispute centers on employee vs. independent contractor status, as the tax consequences between the two, for both the employer and the worker, differ significantly.

Employee vs. independent contractor classification hinges on a facts-and-circumstances test, and each business relationship requires analysis to determine worker status.

Noting that taxpayers often struggle with this determination, the IRS issued Announcement 2012-45 and Announcement 2012-46 to expand the qualification criteria for relief under the Voluntary Classification Settlement Program (VCSP). By increasing the scope to allow additional taxpayers to qualify, as well as extending the deadline for qualification until June 30, 2013, in certain situations, the IRS has offered enhanced relief for affected taxpayers.

Employee vs. independent contractor

Worker status, as mentioned above, has long been an area of concern for taxpayers and government agencies alike. With increased technology and information transparency, the government agencies continue to focus on the potential misclassification of workers. IRS Publication 15-A, Employer’s Supplemental Tax Guide, provides guidance in this area, stipulating that the business relationship between the employer and the worker will drive the determination. While a large number of factors are weighed, generally a worker will be considered an employee if he or she:

  • Performs duties dictated or controlled by others (i.e., behavioral control);
  • Is provided with specific training for the duties to be performed;
  • Works for one employer (i.e., financial control); or
  • Receives compensation in the form of wages.

Conversely, independent contractors retain increased flexibility in comparison to their fellow employees. An independent contractor:

  • Operates and advertises under a business name;
  • May have his or her own employees;
  • May have multiple employers;
  • Sets his or her own schedule;
  • Prepares invoices for the duties performed.

While independent contractors do enjoy increased flexibility, the employer/employee relationship provides structure and stability that many workers appreciate, as well as lower employment taxes for employees.

Why does it matter?

In most instances, the hiring of independent contractors is less burdensome to companies when compared to the hiring of full-time or part-time employees. For example, companies are not required to remit federal or state income taxes, Social Security, Medicare, or unemployment taxes on behalf of independent contractors, but must do so for employees. Additionally, beginning in 2014, employers with 50 or more employees will generally be required to provide and pay for health insurance for the employees or pay a penalty under Sec. 4980H.

With a large number of tax dollars at stake, federal and state taxing authorities have been increasing their examination of these business relationships. The liabilities for taxes and related penalties and interest to business owners could be significant if workers are determined to be misclassified in an examination.

The IRS reacts

In addition to entering into agreements with state taxing authorities to share information and enforce compliance with worker classification laws, the IRS has offered a revised VCSP, expanding the eligibility requirements to allow taxpayers to self-report tax liabilities. This program allows taxpayers to report workers they have misclassified in the past and reclassify these workers for future periods, providing partial relief from federal unemployment taxes for past periods as a means to induce participation.

The VCSP, originally released in Announcement 2011-64, was modified by the December 2012 release of Announcement 2012-45, to:

  • Permit taxpayers under IRS audit, other than an employment tax audit, to participate;
  • Clarify the eligibility requirements of members of an affiliated group if one or more of the members of the group are under examination by the IRS for employment tax issues;
  • Stipulate that a taxpayer who was previously audited by the IRS or the Department of Labor concerning the classification of the class or classes of workers is eligible for the VCSP if the taxpayer has complied with the results of that audit and is not currently contesting the classification in court; and
  • Eliminate the requirement that taxpayers must agree to extend the statute of limitation.

Taxpayers who meet these eligibility requirements must file Form 8952, Application for Voluntary Classification Settlement Program, to participate. In exchange for an agreement to correct the worker classification for future periods, the taxpayer will:

  • Pay 10% of the most recent year’s tax liability that would have been due had the workers been classified appropriately;
  • Not pay any interest or penalties on the balance due; and
  • Not be subject to IRS examination for tax years prior to VCSP enrollment.

Special expanded relief

Announcement 2012-46 also temporarily increases taxpayer eligibility for VCSP participation. This announcement provides for a temporary expansion of eligibility through June 30, 2013, for taxpayers who would otherwise participate in the VCSP, but for the fact that Forms 1099 have not been filed for the three years prior to application for the misclassified workers. In exchange for an agreement to correct the worker classification for future periods, the taxpayer will:

  • Pay 25% of the most recent year’s tax liability that would have been due had the workers been classified appropriately;
  • Pay a reduced penalty for unfiled Forms 1099 for the three years prior to enrollment in the VCSP;
  • Not pay any interest or penalties on the balance due; and
  • Not be subject to IRS examination for tax years prior to VCSP enrollment.

What to do next

Taxpayers who believe an issue or potential issue of worker classification exists should consider enrolling in the VCSP, as eligibility will be restricted should the IRS or Department of Labor contact a business or its representatives before it files for relief under either of these announcements.

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Stephen J. Ehrenberg, CPA, MBT, is a tax principal in the Los Angeles office of Holthouse Carlin & Van Trigt LLP.