Volume 23 Issue 5 -- September/October 2011
Many
small businesses designate workers as “independent contractors,”
regardless of whether they are really employees, to avoid paying the
employer’s portion of Social Security and dealing with employee tax
withholding and the related paperwork and reporting.
The
practice of classifying workers as independent contractors may have
grown in the recent past perhaps because there have been relatively
fewer IRS employment tax audits. Nevertheless, this is still a risk to
businesses.
The
IRS has announced a new program to promote voluntary reclassification
of workers treated as “independent contractors” but that are in reality
“employees.” The announcement may be seen as a tacit acknowledgement
that the IRS lacks the staff to do employment tax audits on a large
scale.
The
IRS calls its new procedure a Voluntary Classification Settlement
Program or “VCSP.” The VCSP program is intended by the IRS to provide
relief to businesses with misclassified workers similar to the relief
available for businesses current under employment tax audit through
what the IRS calls the “Collective Settlement Procedure.”
To
be eligible to voluntarily reclassify for future years workers that are
currently being treated as independent contractors, two criteria must
be met:
Businesses that have gone through prior employment tax audits must have fully complied with those audit results.
Eligible
businesses that wish to reclassify their workers voluntarily on a
prospective basis must pay 10% of the employment tax liability due on
the compensation paid to the workers for the most recent tax year,
using reduced rates under Internal Revenue Code (IRC) § 3509.
Such businesses will not be required to pay interest or penalties on
this 10% tax liability, and they will not be subject to employment tax
audits with respect to those workers for prior years.
There
is one other condition that may not be that important in most
circumstances. The statute of limitations on employment tax auditing is
normally three years after a return is filed. In order to participate
in the VCSP, the business must agree to extend the statute of
limitations from three to six years. This applies to employment tax
audits with respect to the first three years after the date the workers
are reclassified.
Eligible businesses must submit a new form, Form 8952, entitled “Application for Voluntary Classification Settlement Program,” consisting of two pages. The first page has questions relating to identification of the business, the contact person, and
information
about the workers to be reclassified. Page 2 has a section for
calculating what the tax liability would be on the past year’s workers
using the reduced rates of IRC § 3509(a).
The
10% payment is not made with Form 8952 but rather is submitted with a
signed “closing agreement,” prepared presumably by the IRS. A Closing
Agreement is a procedure that binds all parties, including the IRS.
Businesses
that wish to apply need to allow at least a 60-day waiting period after
Form 8952 is submitted before the reclassified workers can be treated
as employees. For example, if a business wants to begin treating its workers as employees on January 1, 2012, Form 8952 needs to be submitted on or before Nov. 2, 2011.
Stated
differently, the business needs to think ahead and file the form at
least sixty days (two months) before the beginning of the period for
which they want to treat the workers as employees. Both the form and
the instructions are available on the IRS website.
There
are two significant benefits from the VCSP. First, it allows businesses
with misclassified workers the chance to reclassify them prospectively
and eliminate the risk of an audit for the past three years.
Second,
the financial cost of doing this requires paying only 10% of the
employment taxes that otherwise would have been due for just the past
year while at the same time avoiding additional tax, interest and
penalties with respect to the past three years.
Businesses
that are currently not filing Forms 1099 for independent contractors
will not be eligible to participate in the VCSP.
It
is possible that some, perhaps many, small businesses will not want to,
or cannot qualify to, participate in the VCSP program. Some
businesses have already determined that it is impossible for them to
reclassify workers as “employees” and still compete effectively against
businesses which do pay employment taxes.
If you need assistance in determining whether or if a client should participate in the VCSP, please contact Tax & Business Professionals.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.
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