For taxpayers under IRS examination, the current Classification Settlement Program (CSP) is available to resolve federal employment tax issues related to worker misclassification, if certain criteria are met. The CSP is designed to approximate the results businesses with Section 530 disputes could obtain by exercising their appeal rights. If a CSP settlement offer is made by the examiner and accepted by the business, the parties sign a closing agreement. The business must agree to properly classify its workers prospectively, effective on the first day of the next quarter (i.e., worker classifications on returns for prior tax years will be accepted as filed).
IRS Launches Voluntary Settlement Program
The IRS has decided to provide taxpayers with a program that allows the voluntary reclassification of workers as employees outside of the examination context. So on September 21, 2011, it launched a new program that will enable many employers to resolve past worker classification issues by voluntarily reclassifying their workers. “This settlement program provides certainty and relief to employers in an important area,” said IRS Commissioner Doug Shulman. “This is part of a wider effort to help taxpayers and businesses [by giving] them a fresh start with their tax obligations” (News Release IR-2011-95).
To be eligible, a taxpayer must have consistently treated the workers as nonemployees, and must have filed all required Forms 1099 for the workers for the previous three years (Announcement 2011-64, 2011-41 IRB). The taxpayer cannot currently be under audit by the IRS, or under an audit addressing the classification of the workers by the Dept. of Labor or a state government agency. To apply, the taxpayer should submit Form 8952 (Application for Voluntary Classification Settlement Program).
A taxpayer who participates in the VCSP will agree to prospectively treat the workers as employees for future tax periods. In exchange, the taxpayer will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under IRC Sec. 3509, but will not be liable for any interest and penalties and will not be subject to an employment tax audit for the workers for prior years. However, the taxpayer must agree to extend the statute of limitations on assessment of employment taxes for three additional years for the first, second and third calendar years beginning after the date the taxpayer begins treating the workers as employees.
Observation: According to News Release IR-2011-95, employers accepted into the program will pay an amount effectively equaling just over 1% of the wages paid to the reclassified workers for the past year.
Applying for the Voluntary Settlement Program
Information about the VCSP and the application will be available on www.irs.gov. Along with the application, the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848) should be provided. The IRS will contact the taxpayer or authorized representative to complete the process once it has reviewed the application and verified the taxpayer's eligibility. The IRS retains discretion whether to accept a taxpayer’s application for the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.
Settlement Program Frequently Asked Questions
Further details are available on the Employment Tax pages of the IRS website, which includes a series of Frequently Asked Questions (FAQs) at www.irs.gov/businesses/small/article/0,,id=246014,00.html. Excerpts from the FAQs are reproduced below—see the website for the full text.
Do all workers have to be reclassified as employees?
The VCSP permits taxpayers to reclassify some or all of their workers. However, once a taxpayer chooses to reclassify certain of its workers as employees, all workers in the same class must be treated as employees for employment tax purposes.
Example: ABC Company is a construction firm that contracts with its drywall installers, electricians and plumbers to perform services at housing construction sites. ABC decides to voluntarily reclassify its drywall installers as employees. It submits an application, is accepted into the VCSP, and enters into a closing agreement with the IRS. Once the VCSP closing agreement is executed, ABC must treat all drywall installers as employees for employment tax purposes.
Which taxpayers are eligible for the VCSP?
To be eligible for the VCSP, a taxpayer must be treating the workers as independent contractors or other nonemployees and must have consistently treated the workers as nonemployees, including having filed any required Forms 1099 with respect to each of the workers for the past three years. In addition, the taxpayer cannot be currently under audit by the IRS and cannot be under audit by the Dept. of Labor or any state agency regarding the classification of the workers.
Exempt organizations and government entities are eligible if the eligibility requirements are met.
How does a taxpayer take part in the VCSP?
To participate in the VCSP, an eligible taxpayer must submit Form 8952 (Application for Voluntary Classification Settlement Program), which will be available in early October. The application should be filed at least 60 days from the date the taxpayer wants to begin treating its workers as employees.
What happens once the VCSP application has been submitted?
Once submitted, the IRS will review the application and verify the taxpayer’s eligibility. Once the IRS accepts the taxpayer into VCSP, the IRS will contact the taxpayer (or the taxpayer’s authorized representative) to enter into the VCSP closing agreement with the IRS.
When does the taxpayer pay the amount due under the VCSP?
Taxpayers must make full and complete payment of any amount due under the VCSP when they return the signed VCSP closing agreement to the IRS.
What are the results of participating in the VCSP?
A taxpayer who participates in the VCSP agrees to treat the class or classes of workers as employees for future tax periods for employment tax purposes and will not be subject to an employment tax audit for those workers for prior years. The taxpayer will pay 10% of the employment tax liability that may have been due on the compensation paid to the workers, calculated at the reduced rates of IRC Sec. 3509, for the most recent year, with no liability for any interest or penalties. In addition, the taxpayer will extend the period of limitations on the assessment of employment taxes for three years for the first, second and third calendar years beginning after the date the taxpayer agreed to begin treating the class or classes of workers as employees.
How is the amount of the VCSP payment calculated?
Payment under the VCSP is 10% of the amount of employment taxes calculated under the reduced Section 3509 rates for the compensation paid in the most recent tax year to the workers being reclassified. Under IRC Sec. 3509, the effective tax rate for compensation up to the Social Security wage base is 10.68% in 2010 or 10.28% in 2011, and 3.24% for compensation above the Social Security wage base.
The amount due under the VCSP is based on compensation paid in the most recently closed tax year, determined at the time the VCSP application is being filed. Accordingly, the 10.68% effective rate applies under the VCSP in 2011 since the most recently closed tax year is 2010. The 10.28% effective rate applies under the VCSP in 2012 since the most recently closed tax year is 2011. The rate of 3.24% applies to compensation above the Social Security wage base in both situations. These effective rates constitute the sum of the rates as calculated under IRC Sec. 3509.
Example: In 2010 you paid $1,500,000 to workers that are the subject of the VCSP. All of the workers were annually paid less than the Social Security wage base ($106,800 for 2010). You submit the VCSP application on October 1, 2011 and want the beginning date of the quarter for which you want to treat the class or classes of workers as employees to be January 1, 2012. You look to amounts paid to the workers in 2010 for purposes of calculating the VCSP amount, since 2010 is the most recently completed tax year. The employment taxes applicable to $1,500,000 would be $160,200 (10.68% of $1,500,000). Under the VCSP, your payment would be 10% of that amount, or $16,020.
Will I be contacted if my application is rejected?
If you are not eligible, the IRS will contact you to inform you that your VCSP application has not been accepted. If your VCSP application has been rejected because you are not eligible, you may reapply.