What if you've reviewed the IRS factors and think maybe a worker is classified wrong? You're not the first business owner to get a knot in your stomach after reading through that list.
Fortunately, the IRS has developed a program that allows a business to resolve past worker classification issues by voluntarily reclassifying their workers without undergoing an audit.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is an employment tax settlement program offered by the IRS that allows a business to reclassify as employees those workers it erroneously treated as independent contractors. The program has generous payment terms, and participants get relief from employment tax audits for previous years.
Who is Eligible?
The VCSP is available to taxpayers who have consistently treated their workers (or a group of their workers) as independent contractors and now want to begin treating them as employees. To be eligible, the taxpayer must have filed all required Forms 1099 for the workers for the previous 3 years within 6 months of the Form 1099 due dates (including extensions).
A taxpayer who is currently under an IRS employment tax audit isn’t eligible for the program. Similarly, a taxpayer who is under audit for worker classification issues by the IRS, the Department of Labor (DOL), or a state government agency is ineligible. However, a taxpayer that was previously audited by the IRS or the DOL for worker classification is eligible if it has complied with the results of that audit.
If a corporate taxpayer’s parent, subsidiary, or other member of its consolidated group is under audit, then the taxpayer can’t participate in the VCSP. An audit of one member of a taxpayer’s consolidated group is treated as an audit of the taxpayer for these purposes.
Terms of the Program
Once accepted into the VCSP, the taxpayer must agree to treat the class of workers as employees for future tax periods. The taxpayer must also agree to allow the IRS an extra 3 years to assess employment taxes. This extension applies for the first 3 calendar years beginning after the agreement takes effect.
In exchange for making these concessions, the taxpayer gets the following benefits:
1. The taxpayer must pay only 10% of the employment tax liability on compensation paid to the workers for the most recent tax year, determined under reduced rates (see “Figuring the Payment,” below);
2. The taxpayer won’t be liable for any interest and penalties on the employment taxes; and
3. The taxpayer won’t be subject to an employment tax audit for the classification of the workers for prior years.
Taxpayers may choose to reclassify some or all of their workers. However, once a taxpayer chooses to reclassify certain workers as employees, it must treat all workers in the same class as employees.
Figuring the Payment
The payment due under the VCSP is 10% of the employment taxes, calculated under reduced rates, on the compensation paid to the reclassified workers in the most recently completed tax year, determined at the time the VCSP application is filed.
If you apply for the VCSP in 2022, the most recently completed tax year will be 2021. The reduced rate is 10.68% of compensation up to $142,800 (the social security wage base for 2021; the wage base for 2022 is $147,000) and 3.24% of compensation above $142,800. You’ll pay only 10% of that amount.
Illustration: A company paid $1.5 million in 2021 to workers that are the subject of a VCSP application. None of the workers were paid more than $142,800 in wages. The company submits its application on October 1, 2021. It wants to begin treating the workers as employees on January 1, 2022. The company calculates the payment due based on amounts paid to the workers in 2021, because 2021 was the most recently completed tax year when the application was filed. Under the reduced rates, the employment taxes on $1.5 million of wages would be $160,200 (10.68% of $1.5 million). The company’s VCSP payment would be 10% of $160,200, or $16,020.
Procedure to Apply
Taxpayers apply to participate in the VCSP by filing Form 8952 with the IRS at least 60 days before the date they want to begin treating the workers as employees. No payment should be made at that time. After the IRS reviews the application, it will contact the taxpayer, or the taxpayer’s authorized representative, to complete the process.
Taxpayers who are accepted into the VCSP must enter into a closing agreement with the IRS. Full payment is due when the taxpayer returns the signed closing agreement to the IRS.
Should you participate?
Although the VCSP’s terms are generous, any decision to participate must be made carefully, after weighing the costs and benefits. Agreeing to treat workers as employees may have far-reaching consequences under a variety of federal and state statutes. The right choice may depend on how clear it is that the workers are in fact employees.
Let's discuss the pros and cons of participating in the VCSP for your specific situation and help you determine how to proceed. Please reach out and arrange a time for us to connect.