Wednesday, January 9, 2013

United States: IRS Guidance Favorably Modifies Voluntary Worker Classification Settlement Program


One year ago the Internal Revenue Service (IRS) published Announcement 2011-64, which provided a Voluntary Classification Settlement Program (VCSP) for employers to treat their workers as common law employees rather than independent contractors only on a prospective basis.  Now the IRS has issued two new announcements that favorably modify and expand the VCSP.  Because certain favorable tax relief is available only for applications filed before June 30, 2013, employers should review quickly their worker classification issues in light of this new guidance.

On December 17, 2012, the Internal Revenue Service (IRS) issued Announcements 2012-45 and 2012-46 to revise the tax relief for employers that utilize the Voluntary Classification Settlement Program (VCSP).  Originally established in December 2011, the VCSP permits eligible taxpayers to voluntarily reclassify their workers for federal employment tax purposes and obtain limited tax relief for previous nonemployee treatment.


The IRS overwhelmingly favors classification of workers as employees rather than independent contractors in part  because withholding of employment taxes is required for the former and not the latter.  Whether a worker is performing services as an employee or as an independent contractor depends upon numerous facts and circumstances, but the most important factor is whether the worker is subject to the employer's right to direct and control the worker as to what and how services are performed.  The determination of a worker as an employee is often not self-evident.  For employers under IRS examination, the Classification Settlement Program (CSP) is available to resolve federal employment tax issues related to worker misclassification if certain requirements are met.  The CSP allows the prospective reclassification of workers as employees with reduced federal employment tax liabilities for past nonemployee treatment.  The IRS determined it also would be beneficial to offer employers a program that allows voluntary reclassification of workers as employees without paying all past employment tax liabilities and without correcting past employer quarterly federal tax returns (Form 941).  Accordingly, the IRS issued Announcement 2011-64 last year.  The tax relief available under the VCSP—only 10 percent of the employment tax liability for one year—is similar to that available under the CSP, and the VCSP has become very popular.


Generally to participate in the VCSP, the employer must have consistently treated its workers in the past as nonemployees, must have filed all required Forms 1099 for the workers for the previous three years, must apply to participate in the program and must enter into a closing agreement with the IRS.  To use the VCSP, the employer also cannot currently be under audit by the IRS, the U.S. Department of Labor (DOL) or a state agency concerning the classification of the workers at issue.


The original VCSP has been modified by Announcement 2012-45 to:
  • Permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate
  • Clarify the current eligibility requirement that a taxpayer that is a member of an affiliated group within the meaning of Internal Revenue Code (Code) Section 1504(a) is not eligible to participate if any member of the affiliated group is under employment tax audit
  • Clarify that a taxpayer is not eligible to participate if the taxpayer is contesting in court the classification of the class or classes of workers from a previous audit by the IRS or the DOL 
  • Eliminate the requirement that a taxpayer agree to extend the period of limitations on assessment of employment taxes as part of the closing agreement with the IRS
Additionally, Announcement 2012-46 temporarily expands the VCSP to taxpayers who would otherwise be eligible, but have not filed all required Forms 1099 for the previous three years with respect to the workers to be reclassified, provided the taxpayer pays 25 percent of the employment tax liability that would have been due on the compensation being reclassified for the most recent tax year, and meets certain other requirements, including filing Forms 1099 for the past three years and paying an additional graduated penalty.  The expanded eligibility is only available for applications filed by June 30, 2013.


An employer that participates in the VCSP agrees to prospectively treat the class of workers identified in the application as employees for future tax periods.  In return, employers that properly filed Forms 1099 are only required to pay 10 percent of the employment tax liability that would have been due on compensation paid to the workers being reclassified for the most recent tax year if those workers were classified as employees for such year, as determined under the reduced rates of Code Section 3509(a).  Employers that did not properly file Forms 1099 have similar relief, but must pay 25 percent of the employment tax liability and meet other requirements.  However, this relief is only available until June 30, 2013.  In addition, under either correction program the employer is not liable for interest and penalties on the employment tax liability and will not be subject to an employment tax audit with respect to the worker classification for prior years.
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