Many small businesses attempt to save taxes and employee benefit costs by classifying their workers as independent contractors. When business owners classify workers as independent contractors they do not pay the employer’s share of Social Security and Medicare costs, state employer taxes, state unemployment insurance taxes, and workers’ compensation insurance premiums.
Independent contractors also do not receive employee benefits or paid time off.
In many circumstances, this independent contractor status is frivolous. The IRS estimates that unemployment taxes are almost 20% of the suspected annual $345 billion “tax gap”. (The tax gap is the difference between taxes that are voluntarily reported, versus the taxes that are actually owed with full reporting.)
In Announcement 2011-64, the IRS is offering a generous amnesty program regarding past misclassification of employees. Putting aside other possible adverse consequences, the Voluntary Classification Settlement Program (VCSP) is shockingly generous. A taxpayer who participates in the VCSP must agree to:
Prospectively treat the workers as employees for future tax periods.
- Pay only ten percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year. The employer will not be liable for any interest and penalties on any liability and will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years. As a rule of thumb, the amount owed will probably be a little over one percent of the last year’s amount paid to the reclassified workers.
- For the next three years, agree to extend the statute of limitations on assessment of employment taxes for an additional three years. Absent the VCSP, the statute of limitations would be three years.
Importantly, the VCSP program covers only the IRS. Amounts owing to workers compensation insurance carriers, state taxing authorities and the Department of Labor (DOL) are NOT being forgiven through the VCSP. Consequently, participation in the VCSP is significantly complicated by other risks that occur when a worker is misclassified.
The determination of whether a worker is an employee or an independent contractor is based on a common law test that requires significant judgment. If litigation is required, the presentation can usually be improved with a testifying accountant who can both (i) present the business’s situation, and (ii) draw comparisons to other economic situations that provide important insights as to the correct answer.
In this expanded article, we address the following:
- The complicated and subjective factual analysis necessary to determine the proper classification of a worker
- The adverse consequences that could occur under this program