Employee or independent contractor?

Whether a worker is performing services as an employee or an independent contractor generally is dependent on whether the service recipient has the right to control and direct the services provided by the worker.

Misclassifying a worker as an independent contractor instead of an employee can result in severe consequences for the employer, including a failure to pay required payroll taxes on compensation paid to the worker. Trying to fix a misclassification on a prospective

basis has, in the past, often presented the issue of whether to also address
this retroactively and/or a heightened exposure to the IRS seeking a retroactive reclassification and the associated liability for taxes, interest and penalties. As a result, employers have tended to just stay the course and live with the misclassification risk.

The IRS recently launched a new voluntary correction program, known as the Voluntary Classification Settlement Program (VCSP) that allows employers to voluntarily reclassify workers from independent contractors to employees at a greatly reduced retroactive payroll tax cost.

To be eligible for the VCSP, the employer:

1. Must consistently have treated the workers in the past as non-employees;
2. Must have filed all required Forms 1099 for the workers for the previous three calendar years before the date of the application;
3. Cannot currently be under audit by the IRS, the Department of Labor (“DOL”) or a state agency concerning the classification of these workers; and
4. Must have complied with results of a prior examination if the employer was previously audited by the IRS or DOL for the classification of workers.

To participate in the VCSP, the employer must file Form 8952, Application for Voluntary Classification Program.

Form 8952 can be filed at any time, but should be filed at least 60 days before the date the employer wants to begin treating the class or classes of workers as employees.

Employers that are eligible and participate in the VCSP will receive the following relief:

1. The employer only will be required to pay an amount equal to 10% of the employment tax liability that may have been due on compensation paid to the reclassified workers for the most recent tax year (which is approximately 1% of the compensation paid to the reclassified workers for the most recent year) (the “VCSP Payment”);
2. No penalties or interest will be due on the VCSP Payment; and
3. The employer will not be subject to an employment tax audit regarding worker classification for prior years.

To participate in this program, the employer must agree to extend the statute of limitations on assessment of employment taxes from the normal three year period to six years for the first, second and third calendar years after the VCSP closing.

Although the VCSP provides relief from unpaid payroll taxes, employers must be aware of other consequences arising from the reclassification of employees. The areas in which the VCSP provides no relief include:

1. The impact of the failure in the past to make any required pension contributions to a qualified plan with respect to the reclassified workers;
2. The impact of the failure in the past to provide health and welfare benefits to the reclassified workers; and
3. The impact of the failure to comply with wage and hour laws applicable to the reclassified workers.

For many employers, the VCSP provides an excellent opportunity to begin the proper classification of workers as employees at a modest tax cost. However, proceeding under the VCSP program can open up a Pandora’s box that heightens the exposure to other costs and consequences. Thus, all implications arising from the reclassification of workers should be considered and evaluated with your lawyer or accountant before deciding to seek relief under the VCSP.