The IRS is cracking down on businesses who classify workers as independent contractors, but who should be employees. In 2011, the IRS created a new program regarding workers misclassified as independent contractors or nonemployees. Businesses classify workers as independent contractors because they want to save on payroll tax.
The Voluntary Classification Settlement Program (VCSP) lets employers voluntarily reclassify workers as employees for future tax periods without an IRS audit context and outside the need to go through usual correction procedures. To keep businesses out of trouble with the Department of Labor (DOL) or state taxing authorities, the IRS advised people interested in the program that it will not share information about VCSP applications with the DOL or the states. This will incentivize people to reclassify because they will worry less about penalties from the DOL or the states, and in the end, the DOL and states win because as workers get reclassified, there are fewer worker complaints to the DOL, and more state tax revenue.
An employer contacted by the IRS about an SS-8 determination letter is eligible for VCSP, but an audit of a parent, subsidiary or member of the employer’s consolidated group is considered an audit of the applicant and would make the employer not eligible for VCSP.
Signing the VCSP closing agreement is not an admission of any liability or wrongdoing for prior years. Rejection of a VCSP application will not automatically trigger an audit. More details on VCSP are found at the IRS website: http://www.irs.gov/businesses/small/article/0,,id=246014,00.html.
Recent studies suggest about 10% to 30% of employers misclassify their workers as independent contractors per the Internal Revenue Code 20-factor test. The DOL, the National Labor Relations Board, the Equal Employment Opportunity Commission, and states all use different tests to evaluate if a worker is an employee or an independent contractor. An employer may be able to justify classifying a worker as an employee in one context and at the same time, classify the worker as an independent contractor in another situation.
Misclassification can have significant financial consequences for businesses when audited. These consequences can put a company out of business and result in back taxes, penalties and interest. The financial consequences are calculated based on what a business should have paid for taxes had a worker been appropriately classified as an employee rather than an independent contractor.
For individuals or businesses with complex tax questions, contact an experienced Massachusetts tax attorney.
