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Employers Playing Tax Games with Workers: IRS Offers Way to Come Cleanpage item

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 New IRS Voluntary Worker Classification Settlement Program
Past Payroll Tax Relief When Employer Agrees to Reclassify Their Workers as Employees

Background and Overview of the Payroll Problem:

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Written by: Steven J. Fromm, J.D., LL.M. (Taxation)

Many employers have tried to avoid payroll taxes by treating workers as independent contractors.  Employers merely gave the employees a Form 1099 at the end of the year rather than complying with their withholding of income and social security taxes.  As a result, the employee would find out the following April 15 that they owed income taxes on payments made to them during the taxable year. In addition, the employee misclassified as an independent contractor would end up footing the bill for both the employer and employee share of the social security taxes due.   The employees end up owing more taxes than they should be responsible for if the employer had treated the workers as true employees under federal tax laws. 

Upon a payroll tax audit by the IRS,  the employer finally gets caught and ends up with a very large, if not overwhelming, tax problem due its failure to classify its employees correctly.  In addition to the delinquent taxes, interest and penalties further compound the tax problems of the employer.

The government losses since taxes go uncollected. With our country's huge deficit problem, this area of the law is being targeted by the IRS as an abuse area.  

As a result, all parties are impacted here adversely; employees who pay too much, employer getting caught with large tax liabilities and the IRS that is caught policing this abuse area of the tax law.  This is why the IRS just announced a new program addressing these chronic problems.  

New and Favorable Response to this Payroll Tax Problem by the IRS

This new voluntary worker classification program will enable many employers to resolve past worker classification issues with the IRS.  They can obtain certainty as to their payroll responsibilities under this new procedure.  It can be done at a low tax cost as long as the employer agrees to voluntarily reclassifying their workers as employees.  For a small payment payment covering past payroll tax obligations, the employer can have peace of mind by ending the uncertainty of a future messy, costly and time consuming IRS audit. 

Benefits of the New Voluntary Classification Settlement Program  (VCSP)

To briefly summarize, here are the benefits of this new Voluntary Classification Settlement Program (VCSP) as touted by the IRS:

  • Eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past, if they prospectively treat workers as employees.
  • Increases tax compliance of employers
  • Reduce burden for employers by providing greater certainty for employers, workers and minimizing the chances of a government tax audit. 

Who are the Eligible Employers that Can Use the VCSP

The VCSP is available to many businesses, tax-exempt organizations and government entities that currently erroneously treat their workers or a class or group of workers as non-employees or independent contractors, and now want to correctly treat these workers as employees.  To be eligible, an applicant must:

  • Consistently have treated the workers in the past as nonemployees,
  • Have filed all required Forms 1099 for the workers for the previous three years
  • Not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers 

How to Apply with the IRS

Interested employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before they want to begin treating the workers as employees. 

Tax Breaks and Conditions of the VCSP

Employers accepted into the program will obtain the following benefits under the following conditions:

  • Employer must pay an amount effectively equaling just over one percent of the wages paid to the reclassified workers for the past year.
  • No interest or penalties will be due, 
  • Employers will not be audited on payroll taxes related to these workers for prior years.
  • Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. 

Bottom Line and Warning To Employers

This is a great tax break for employers who have taken questionable positions in classifying workers as independent contractors.  Remember the IRS has some very detailed tests in determining who is an employee versus an independent contractor.  For example, if you are controlling and directing these so called independent contractors, they do not set their own hours of work, they do not have other clients other than you, or they are not generating a separate business profit as an independent contractor, you probably have a problem that needs to be addressed with your tax attorney.  For a discussion of the determination of whether a worker is an independent contractor or employee please read the following hypertext article Employee or Independent Contractor.  This IRS tax relief program is a good deal for many employers, so do not wait until you are audited because then it is too late.

Copyright © 2011 - Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.

Published September, 2011. 

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