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IRS Announces Voluntary Program to Reclassify Workers as Employees

Many organizations have workers whom they would classify as independent contractors but whose actual status per IRS rules is that of an employee. If the IRS audits a company and reclassifies workers from independent contractor to employee status, the company can be subject to taxes, penalties, and interest due for prior periods on the unpaid payroll taxes. There have been numerous audits and court battles over this issue and the IRS feels that there continues to be considerable noncompliance in this area. Accordingly, the IRS is looking to set the record straight by giving employers a chance to reclassify their workers as employees for future years at a much lower cost to the employer, without having to go through the process of an audit. The program is called the Voluntary Classification Settlement Program. If you have any workers who are currently receiving a 1099 and should be receiving a W-2, now may be a good time to decide whether the company should make the switch. 

Determining whether someone is truly an independent contractor versus an employee entails a facts and circumstances analysis. However, there are three common-law rules developed by the IRS to help make this decision. The most common test is the type of control the employer has over the individual. If the employer is able to direct and control the worker as to where, when, or how to perform services, he or she should generally be classified as an employee. The other two tests are (1) whether the business aspects of the job are controlled by the employer, e.g., does the independent contractor have any risk of loss, and (2) whether there are any written contracts or employee-type benefits associated with the individual. 

In order to participate in the program, there are three initial eligibility requirements set forth by the IRS. The employer

• must have consistently treated the workers as nonemployees;
• must have filed all Forms 1099 for the workers for the previous three years;
• cannot currently be under audit by the IRS, the US Department of Labor, or any state government agency.

An employer participating in the program will be required to pay 10 percent of the employment tax liability, calculated under the reduced rates of IRC section 3509(a), that would have been due on the compensation paid to the workers for the most recent closed tax year. For 2010, the rate applied to wages below the FICA threshold was 10.68 percent. Paying in 10 percent of that amount would equal an amount just over 1 percent of wages paid to the reclassified workers for the past year, with no additional interest or penalties due. This is a major benefit for companies with workers at risk of reclassification because, without this program, employers would be required to pay all federal payroll taxes from the past three years, as well as penalties and interest, as determined by the IRS. 

Additionally, employers participating in the program will be subject to a special six-year statute of limitations for the assessment of employment taxes for the first three years under the program, rather than the usual three years. Employers will NOT, however, be subject to a prior-period payroll tax audit with respect to the workers who have been reclassified. 

Generally speaking, an employer will look at each class of workers differently when making the determination. This voluntary program allows employers to reclassify some or all of their workers. Once a taxpayer chooses to reclassify certain individuals as employees, all workers in the same class must generally be treated as employees for payroll tax purposes. 

If you fit the requirements and think that your independent contractors should be classified as employees, the next step is to complete the application, and when approved, enter into a closing agreement with the IRS. Form 8952, Application for Voluntary Classification Settlement Program, is available on the IRS website, or you can contact your Blackman Kallick representative to help with the process. This form should be filed at least 60 days before the date the employer wants to start treating the workers as employees. 

For further information please contact Kelsey Popkins at kpopkins@BlackmanKallick.com or 312-980-3370, Nora Stapleton at nstapleton@BlackmanKallick.com or 312-980-2933, or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.