Godfrey & Kahn Updates
December 13, 2011
by Wendy Richards and Sven E. Skillrud
New IRS Voluntary Classification Settlement Program
In a September 19, 2011 press release, the Internal Revenue Service (IRS) and Department of Labor (DOL) announced coordinated and targeted enforcement efforts against businesses that misclassify workers as independent contractors. While the IRS previously indicated it will focus on worker classification with regard to its employment tax audit initiative announced in February 2010,1 the IRS and DOL will now share information and collaborate together. Eleven states have also agreed to cooperate with the DOL on worker classification matters -- including Connecticut, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, Missouri, Montana, New York, Utah and Washington, but not currently including Wisconsin.
Voluntary Classification Settlement Program
A few days after announcing joint enforcement efforts with the DOL, the IRS announced a new Voluntary Classification Settlement Program (the "Voluntary Program").2 Futhermore, in November 2011, the IRS updated its "Frequently Asked Questions" to provide additional guidance and clarifications.
Under the Voluntary Program, an employer prospectively reclassifies workers as employees and pays a limited employment tax liability for past treatment as independent contractors. If accepted into the Voluntary Program (at the discretion of the IRS), an employer enters into a closing agreement that extends the statute of limitations on the assessment of employment taxes for three years for the first, second and third calendar years following the date the employer agrees to classify workers as employees. However, the employer is protected against prior assessments for the reclassified workers.
To be eligible for the Voluntary Program, the following should apply:
- Willing to Reclassify Prospectively. The employer should currently treat workers (or a class or group of workers) as independent contractors and be willing to prospectively treat workers as employees. The employer cannot revert to treating the workers as independent contractors.
- Compensation Reported on Forms 1099. The employer should have filed all Forms 1099 for the past three years for all reclassified workers. The Forms 1099 must have been filed no more than six months after the applicable due date (including extensions).
- Audit Limitations. The employer must not be under audit by the IRS, DOL or a state government agency regarding the classification of its workers. If an employer was previously under audit by the IRS or the DOL, the employer will become eligible for the Voluntary Program when the employer complies with the audit results, such as a closing agreement. (If the IRS contacted an employer for more information because a worker claimed he or she was misclassified (via Form SS-8), the employer is not considered to be under audit and may still be eligible for the Voluntary Program.)
What Are The Benefits Of The Voluntary Program?
There are several benefits if an employer is accepted into the Voluntary Program including:
- No "Reasonable Basis" Threshold. The employer does not have to show a "reasonable basis" for previously classifying workers as independent contractors, which is different from the requirements of Section 530 of the Revenue Act of 1978.3
- Reduced Costs. The employer pays the IRS an amount equal to 10 percent of the applicable employment taxes for reclassified workers that would have been due for the most recent tax year. Generally, this equates to about one percent of the reclassified workers' compensation for the prior tax year. Except for this much reduced payment, no other interest or penalties apply.
- Protection Against IRS Action for Past Classification. The employer will not be subject to an employment tax audit with respect to reclassified workers for all prior years, which means the employer will not be liable for past taxes and penalties for misclassified workers. However, keep in mind that the statute of limitations will be extended for three years as described above. For example, if the employer enters the Voluntary Program in 2012, then the statute of limitations for 2013, 2014 and 2015 will each be extended by three years.
The recently issued IRS "Frequently Asked Questions" (FAQ) regarding the Voluntary Program provides the following additional information and clarifications:4
- Reclassify Workers as Appropriate. Not all independent contractors must be reclassified, but once a certain class of workers is reclassified as employees, all workers in that same class must be treated as employees.
- No Payment Due with the Application. Applications for the Voluntary Program should be submitted without payment. But, employers should be prepared to submit applicable payments if accepted into the Voluntary Program.
- No Information Sharing. Initially the Voluntary Program did not address treatment for rejected applicants. This was concerning, as applicants would essentially provide a roadmap to the IRS, the DOL or state tax authorities for future enforcement actions. The IRS will not share information about Voluntary Program applicants with the DOL or state agencies. While this provides some level of comfort, it is still not clear whether other agencies could discover that an employer participated, or attempted to participate in the Voluntary Program through other means. For example, such information could be requested as a part of an audit by another labor agency.
- Not an Admission of Wrongdoing. The IRS assures employers that participation in the Voluntary Program is not an admission of any wrongdoing for prior years.
What Is The Application Process For The Voluntary Program?
An employer can apply to the Voluntary Program by submitting a completed Form 8952. Form 8952 should be submitted at least 60 days before the planned effective date for the reclassification, but otherwise no deadline applies provided the employer is eligible. As mentioned above, no payment is due under the Voluntary Program until an employer is accepted and signs a closing agreement with the IRS.
What Happens If The Application Is Rejected From The Voluntary Program?
The IRS assures applicants that a rejected Voluntary Program application will not automatically trigger a Federal tax audit, but an applicant could be audited for another reason.
What Additional Considerations Are There Before Applying To The Voluntary Program?
There are several additional considerations for an employer before applying to the Voluntary Program including:
- Employee Benefit Plan Considerations. The Voluntary Program only addresses employment taxes and does not address the impact on employee benefit plans. Therefore, an employer must consider the impact a worker reclassification would have on all outstanding employee benefit plans. For example, corrective contributions may be required or minimum coverage violations could arise with regard to a qualified retirement plan.
- IRS Discretion. Acceptance into the Voluntary Program is at the discretion of the IRS.
- Reclassification Not Appropriate for All Workers. Properly classifying workers as employees or independent contractors can sometimes be difficult and the subject of reasonable dispute. The Voluntary Program could be an expensive and unnecessary step for an employer that has appropriately classified workers as independent contractors.
For More Information
For more information on determining whether the Voluntary Program is right for you or if you need assistance completing a Form 8952, please contact Wendy Richards, Sven Skillrud or any other member of Godfrey & Kahn's Tax & Employee Benefits Team.
1 See our prior publication "Employment Tax Audits Have Begun" dated July 8, 2010.
2 See IRS Announcement 2011-64.
3 Section 530 is a safe harbor provision that, if certain requirements are met, prevents the IRS from retroactively reclassifying independent contractors as employees and subjecting the employer to federal employment taxes, penalties and interest for such misclassification.
4 The IRS FAQ is available here: http://www.irs.gov/businesses/small/article/0,,id=246014,00.html (last visited December 4, 2011).