Many employers classify some of their workers as "independent contractors" rather than as "employees". Doing so saves the employer from the withholding requirements for payroll taxes as well as the payment of the employer's portion of FICA, Medicare, and FUTA taxes which would otherwise be applicable to the workers' compensation if they were classified as employees. The IRS is on record, however, that many of those workers now classified as independent contractors should in fact be treated as employees for both employee payroll tax purposes as well as other employee benefits. In this regard, in a Report dated June 14, 2013, the Treasury Inspector General for Tax Administration remarked that “The misclassification of employees as independent contractors is a nationwide problem affecting millions of workers that continues to grow and contribute to the Tax Gap." (The Tax Gap is defined in the report as the estimated difference between the amount of tax that taxpayers should pay and the amount that is paid voluntarily and on time.)
Tax Consequences of Improper Classification:
If the IRS conducts an employment tax audit of a taxpayer that results in the reclassification of certain independent contractors as employees, the IRS can usually go back three tax years to assess unpaid payroll taxes. In such event, the past due taxes, along with any applicable tax penalties and interest, can be substantial.
Executive Summary of the Voluntary Classification Settlement Program:
On September 21, 2011, the IRS issued IRS Announcement 2011-64 by which it instituted a new employment tax program, the Voluntary Classification Settlement Program ("VCSP"). Under VCSP, certain employers are allowed to voluntarily reclassify on a prospective basis certain of its independent contractors which given the facts and circumstances should be treated as employees. To be eligible to participate in VCSP, the employer (1) must not be under an IRS or DOL employment tax audit, and (2) must have consistently treated the workers to be reclassified as independent contractors and filed all required Forms 1099 to report the compensation for their services for the previous three years.
How to Participate in VCSP:
The reclassification process is initiated by filing an application on Form 8952 with the IRS. In the Form 8952, the employer identifies the workers being reclassified by job classification, and the employer agrees that the reclassification will be permanent prospectively once the application has been accepted by the IRS and a closing agreement is signed by both the employer and the IRS. In addition, under VCSP, the employer will only be required to pay 10% of the amount of federal employment taxes it would have owed for the most recent tax year which is due with the closing agreement. Furthermore, the IRS will agree not to audit the employer for employment tax purposes for any prior years with respect to those workers being reclassified.
UHY Advisors Experience with VCSP:
The Houston office of UHY Advisors TX, LLC has recently concluded a filing of IRS Form 8952 with the IRS office in Ogden, Utah involving the successful reclassification under VSCP of approximately 50 workers for one of its clients.
What is at Stake from the Perspective of the IRS:
The IRS last conducted a comprehensive worker misclassification estimate of lost tax revenue for the year 1984. At that time, the IRS found that approximately 15% of employers misclassified 3.4 million workers as independent contractors. The Report goes on to demonstrate that, in the case of a worker being paid an annual compensation of $43,007 (the national average wage for 2011 estimated by the Social Security Administration), employers retain $3,710 per worker in unpaid Social Security, Medicare, and federal unemployment taxes, based on 2012 tax rates, by classifying the worker as an independent contractor as opposed to an employee.
Employers with independent contractors should consider whether or not they have a strong fact pattern for treating these workers as independent contractors rather than as employees. If there is any doubt, the IRS will most likely try to reclassify these workers should it audit the employer. If the IRS is successful in reclassifying any of these workers, the past due taxes, plus penalties and interest assessed against the employer, could be substantial. If that occurs, then the payment due with the closing agreement under the VCSP could be a great deal for the employer.
For additional information regarding this topic, please contact your local UHY LLP professional.