IRS Announces New Voluntary Worker Classification Settlement Program

The IRS announced on September 21, 2011 a new program to help employers resolve past problems in classifying workers as independent contractors instead of employees.  There is not a brightline test in properly classifying workers, and errors can be made.  In addition, workers classified as employees are much more costly to a business than if the workers were instead classified as nonemployees.  Examples of additional costs are payroll taxes, health insurance (if offered to employees), and retirement plan (if offered to employees) contributions.  Therefore, some businesses may have tended toward classifying workers as independent contractors.  If the IRS discovers that workers were misclassified, the IRS can impose years of back taxes, interest, and penalties on the employer.  In addition, the employer could be responsible for past overtime pay, retirement plan contributions, and other employee fringe benefits.  With potential penalties building up over the years, employers felt stuck with the problem without a low-cost way of correcting the misclassification.

The new Voluntary Classification Settlement Program enables eligible employers to obtain substantial relief from past taxes if they prospectively treat workers as employees.  To be eligible, a business must:

1. Have consistently treated the workers in the past as nonemployees,
2. Have filed all required Forms 1099 for the workers for the previous three years,
3. Not be currently under audit by the IRS, and
4. Not be currently under audit by the Department of Labor or by a state agency concerning the classification of these workers.

Eligible employers must file Form 8952 with the IRS at least 60 days before they want to begin treating the workers as employees.  For example, application must be made by November 2, 2011 if the workers are to be reclassified effective January 1, 2012.  Employers accepted into the program will pay a penalty of about 1% of wages paid to the reclassified workers for the past year.  No other interest or penalty will be due, and the IRS will not audit the employer for payroll taxes related to these workers for prior years.  In addition, a six-year (instead of the normal three-year) statute of limitations will apply to the first three years after the start of the program.  Additional information is available on the IRS website at: http://www.irs.gov/businesses/small/article/0,,id=246013,00.html

This is a voluntary Federal program.  Participation in the program could be shared with states that may or may not have a voluntary compliance program of their own.  Note also that correcting worker classification may have an impact under the 2014 health insurance mandate for employers having 50 or more employees beginning in 2013.