IRS Offers Amnesty Program for Employers Who Misclassified Employees as Independent Contractors: Is This a Trap for the Unwary?
On September 21, 2001, the Internal Revenue Service launched the Voluntary Classification Settlement Program (VCSP). Under the VCSP, for up to three prior tax years, an employer can apply to retroactively reverse its determination that a class or classes of workers were independent contractors rather than employees for purposes of federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax. In exchange, applicants to the program who are accepted will be liable for only 10% of the taxes that should have been withheld during the period of misclassification; in other words, 90% of the taxes that should have been paid are forgiven. Is this too good to be true? Perhaps it is. We strongly suggest that you consult an attorney before you apply for the VCSP.
To apply, an employer needs to complete Form 8952, Application for Voluntary Classification Settlement Program (VCSP). In the Instructions for Form 8952, the IRS sets forth eight eligibility requirements for the VCSP. To be accepted into the program, an employer must:
- Want to voluntarily reclassify certain workers;
- Be presently treating the workers as non-employees;
- Have satisfied any Form 1099 requirements for every worker in each of the preceding tax years (up to three years back);
- Have consistently treated the workers as non-employees;
- Have no dispute with the IRS that the workers should be treated as employees for federal employment tax purposes;
- Not be under examination by the IRS;
- Not be under examination by the Department of Labor or any state agency for the proper classification of workers; and
- Either not have been previously examined by the IRS or DOL for the classification of workers or have complied with the results of any such previous examination.
The Application for VCSP must be signed by the taxpayer representative, not by a paid preparer, under penalties of perjury for false statement.
One problem with the VCSP, at the outset, stems from the difficulty in determining employer versus independent contractor status in the first place. Deciding whether a worker is an independent contractor or an employee is a highly fact-intensive inquiry. The labels that the worker and service recipient put on their relationship are not determinative. For many employers, making the right call, 1099 versus W-2, is difficult. Moreover, the relationship between worker and service recipient may change over time. A worker who was truly an independent contractor at the beginning may have morphed into an employee with the passage of time, making it difficult to attest that workers who have been treated as independent contractors have always been employees.
Beyond that, the VCSP requires an employer to execute what is essentially an admission to having previously misclassified employees as non-employees. That admission is signed by the taxpayer under penalty of perjury, and would be strong evidence of misclassification if admitted in any legal forum.
The existence of an admission to misclassification is potentially problematic because the VCSP affects only federal employment tax liability. The VCSP does not limit state or local taxing authorities from seeking payments of back taxes, penalties or interest for having misclassified employees as non-employees. Moreover, the VCSP does not limit the Department of Labor or state or local employment law authorities from investigating minimum wage or overtime liabilities that might be owed reclassified workers. Furthermore, the VCSP does not shield an employer from liability for race, age, sex, disability or other protected class discrimination claims that might be brought by a reclassified worker because of the worker’s reclassification as an employee. Additionally, if, by the taxpayer’s admission on Form 8952, a worker should have been classified as an employee, and thereby should have been allowed to participate or automatically enrolled in the employer’s pension and welfare benefit plans, participation in the VCSP could give rise to claims for benefits or other claims under ERISA.
Employers should consult competent legal counsel before applying to participate in the VCSP.
*This post was originally written by Steve Wilson.