Keeping Your Balance: IRS employee vs. contractor compliance program

By James P. Schnell
Posted: 5:56 pm Thu, January 5, 2012

Effective October 2011, the IRS has launched a new voluntary compliance program aimed at encouraging immediate and prospective correction for proper independent contractor vs. employee classification and reporting.

The program is called the Voluntary Classification Settlement Program and was issued in IRS Announcement 2011-64. The program is open to taxpayers, businesses and exempt organizations who want to voluntarily change the prospective classification of their workers.

To be eligible, a taxpayer must have consistently reported their workers as nonemployees, filed Forms 1099 for the workers for the previous three years and the reporting taxpayer cannot currently be under audit by the IRS, Department of Labor or a state government agency concerning the same issue.

A taxpayer who was previously audited by the IRS or the Department of Labor concerning the classification of the workers will only be eligible if the taxpayer has complied with the results of the previous audit.

In exchange for agreeing to voluntarily change the classification of workers to employees, the taxpayer will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year.

This amount will be determined under the reduced rates of IRC Section 3509. This amount due will not be subject to any late interest or penalty calculations. In addition, the taxpayer will not be subject to an employment tax audit with respect to the worker classification issue for prior years.

However, the taxpayer will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

Application for this program begins with the taxpayer filing Form 8952 “Application for Voluntary Classification Settlement Program.” The IRS requests this form to be filed 60 days prior to the period the taxpayer wishes to treat the workers as employees.

The IRS will contact the taxpayer 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.

Taxpayers should note this program only covers federal employment taxes and does not address any state tax issues, nor does it address any possible retirement plan funding, testing or employee benefits issues such a change of classification could bring about.

James P. Schnell, CPA/ABV, CVA, is a tax and business valuation partner with Mengel, Metzger, Barr & Co. LLP. He may be reached at jschnell@mmb-co.com or (585) 423-1860.