Owners and managers of thousands of Michigan businesses have been hoping for years that they would not have to face an employment tax audit, as they know that any workers historically treated as independent contractors have very possibly avoided paying employment taxes, and such an audit would not end well. In an effort to bring these independent contractors under the umbrella of actual employee status (and therefore capture a greater percentage of employee withholding taxes), the IRS has released its first ever Voluntary Classification Settlement Program (VCSP), or in plain English, an employment tax amnesty.
The VCSP includes very generous taxpayer-friendly terms. Those eligible will, with regard to past practices, pay only 10% of last year’s liability, determined under the reduced rates of Internal Revenue Code § 3509, and no penalties. On a prospective basis the employers must begin treating the workers at issue as employees. More details are below. These taxpayer-friendly terms are in stark contrast to the more strident, penalties-enhanced conditions of the highly-publicized offshore account amnesties in 2009 and earlier this year.
The IRS’ motivation for this generous amnesty is that numerous studies over the years have concluded that taxpayer compliance (i.e. workers reporting the income) is about 99% on W-2 income but only in the 85% to 88% range on independent contractors. From the government’s perspective, non-compliance is at least a dozen times higher with independent contractors.
Who is Eligible?
Employers qualifying for amnesties for workers, or classes or group of workers, must:
(a) have consistently treated the subject workers as non-employees,
(b) filed all required Forms 1099 the previous three years for such workers, and
(c) not currently be under examination by the IRS or under audit regarding classification of workers by either the U.S. Department of Labor or a state agency.
Furthermore, a taxpayer employer previously audited by the IRS or the U.S. Department of Labor regarding worker classification will only be eligible if they have complied with the results of that audit.
Terms of the VCSP
An employer participating in the amnesty program must do the following:
- Prospectively treat the class of workers as employees for future tax periods. This, and the future deficit reduction, is the carrot for the IRS to get taxpayers in the system. That is why the IRS is willing to trade near virtual amnesty for past transgressions from those employers it would find on audits against employment tax treatment in the future. (It should be noted that both the IRS and Dept. of Labor are expected to become more aggressive with auditing efforts.)
- Employers will only pay 10% of the employment tax liability that would have been due for compensation paid in the most recent tax years determined under the reduced rates of § 3509 of the Internal Revenue Code;
- The business will not be liable for any penalties or interest (an IRS rarity!);
- The employer will not be subject to employment tax audit regarding worker classifications for such workers for prior years; and
- Employer will sign a Closing Agreement (i.e., a contract with the IRS) agreeing to extend the statute of limitation for assessment for employment taxes for three years for the first, second and third calendar years beginning on the day after the employer has agreed to begin treating such workers as employees. The IRS wants to verify the employer follows through with its end of the deal.
The terms are not only much more generous than those where the IRS audits and changes classifications of worker groups from independent contractors to employees, but also, they are far more liberal than the so-called § 530 reporting consistency requirements. Additionally, other technical aspects that make this a very attractive offer that many cannot and should not refuse.
How to Apply
First and foremost, the employer must decide to enter the amnesty, and for which groups of workers. There will undoubtedly be thought given to which workers or groups should be subject to VCSP. If the decision is to seek relief under VCSP, the next step is to submit an application on just released Form 8952, Application for Voluntary Classification Settlement Program, along with an IRS Power of Attorney. After it is initially reviewed, then the IRS will contact the employer and verify eligibility. Also, at the conclusion of the amnesty process and execution of the Closing Agreement, the employer must make full and complete payments of any amounts due under the Closing Agreement.
Conclusion
For those employers who have felt in their hearts that they would fare poorly upon an IRS employment tax audit, this is a wonderful opportunity to change over to “employee status” without paying large sums for all past years for which their statute of limitation for assessment by the IRS is open. History does repeat itself. In other amnesties, after a given amnesty ends, the IRS then goes out and aggressively audits many taxpayers for the given issue, and those it finds are treated far harsher than those who came in under the amnesty. If the business has some workers or groups of workers it fears would likely be reclassified in an audit and any appeal, then this amnesty program needs to be given serious consideration.
For more information, contact any member of our Tax Planning, Compliance and Litigation Team.