Has your business recently undergone an examination by the state unemployment office? Did that examination result in independent contractors being recharacterized as wage earners? If so, you likely are facing a new tax debt for unpaid unemployment contributions with the state agency. Many businesses are finding themselves in this situation. However, the problem does not end there. The recharacterization will be shared with the federal government, and the IRS will also assess a new debt for unpaid Social Security, Medicare, and income taxes for these employees.
If your business has concerns about the status of independent contractors, there is an opportunity to be proactive and avoid the problems of federal reclassification by examination. Additionally, you can dramatically reduce the overall debt owed to the federal government. The Voluntary Classification Settlement Program (VCSP) was created by the IRS to resolve worker classification issues and provide certainty to taxpayers.
The basic concept of the program is simple: if a business is willing to voluntarily reclassify independent contractors as employees, then the IRS will allow the business to pay a greatly reduced amount for any unpaid Social Security, Medicare, and income taxes for previous periods. The important point is that the business will be required to pay all Social Security, Medicare and income taxes for all future periods after the reclassification has been completed.
When a business applies to the VCSP, the IRS will calculate a fee equal to approximately 1% of the amount paid to reclassified workers in the last calendar year. No further assessment will take place by the IRS if accepted into the program and the employer begins treating the reclassified workers as W-2 employees.
This program has very specific criteria. However, the program is broadly available to businesses, not for profit entities, and governmental entities. In order to be accepted in the program, the taxpayer must meet the following criteria:
- The taxpayer must want to voluntarily reclassify certain workers as employees for federal income tax withholding, Federal Insurance Contributions Act (FICA), and Federal Unemployment Taxes for future periods;
- The employer must be treating the workers as non-employees;
- The employer must have satisfied any 1099 requirements for each of the workers for the 3 years preceding the calendar year ending before the date the request for reclassification is submitted. If the worker didn't work for the employer for the entire three year period, this requirement is met if the Form 1099 has been issued to the worker for the time period he or she did work for the employer;
- The employer must have consistly treated the worker as a non-employee. In other words, a business cannot reclassify a worker who is on a 1099 if that worker was provided a W-2 in a prior year;
- The employer must have no dispute with the Internal Revenue Service as to whether the workers are non-employees for federal employment tax purposes;
- The employer cannot be currently under examination by the IRS;
- The employer must not be under examination by the Department of Labor or any state agency for the proper classification of the worker. This is key a point—if the issue was brought to the taxpayer's attention by a state unemployment agency, the taxpayer will want to apply for this program after the conclusion of the state examination, but before receiving a notice from the IRS that the taxpayer is subject to a federal audit!
- The taxpayer must not have been previously examined by the IRS or the Department of Labor for the classification of worker, or if the taxpayer has been examined previously by either entity, then the taxpayer must have complied with the results of the prior examination.
Finally, there is a provision of the agreement that extends the statute of limitations for assessment of employment taxes for three years for the first, second, and third calendar years beginning after the date the taxpayer elects to begin treating the workers as employees under the program.
The good news is that there is a high level of certainty upon completing this program. Once the proper form is submitted to the IRS, the IRS will review the request and if accepted, enter into a closing agreement with the taxpayer.
To put the importance of this program into perspective, if an employer requested reclassification of workers previously reported on Forms 1099 that totaled $200,000 in the prior calendar year, and the IRS accepted the employer into the program, the employer would pay a fee of approximately $2,000 to address the periods of questionable classification. Absent this program, the employer would pay $26,600 in delinquent Medicare and Social Security taxes alone! This amount would also be increased by unpaid employee income taxes, penalties, and interest.
The Voluntary Classification Settlement Program is part of the IRS Fresh Start program and a wonderful window to avoid burdensome delinquent taxes, penalties, and interest. If you have questions about the VCSP, please feel free to contact our office to learn more.