Recently, the IRS initiated a program for taxpayers who have erroneously classified their employees as independent contractors. This new program, Voluntary Classification Settlement Program (VCSP), provides employers with a relief from Federal Employment Taxes for eligible taxpayers that agree to prospectively treat workers as employees.  Under VCSP, the taxpayers who voluntarily correct misclassifications will receive favorable terms as compared to taxpayers who are forced to make changes as the result of an IRS audit.

To qualify for the VCSP, the taxpayer must fill out new IRS Form 8952, and have consistently treated the workers as contractors, including filing Forms 1099-MISC  for all such workers for the last three years.  In addition, the taxpayer cannot presently be under audit and must agree to treat the workers as employees prospectively.

In return, the “penalty” will be assessed on only one year (instead of three) and the taxpayer will only pay ten percent of the employment tax liability that may have been due on compensation paid in the year most recently completed. Moreover, a taxpayer will not be liable for any additional interest and penalties on the liability and will not be subject to an employment tax audit.  In addition, IRS promises not to inform the Department of Labor or any state agency.

The “employment tax liability that may have been due” in the year most recently completed is calculated using the reduced rates of IRS Code Section 3509(a).  Under that Section:

The tax on compensation under the Social Security Wage Base (SSWB) is 10.68% for 2010 (10.28% for 2011).

The tax on compensation in excess of the SSWB is 3.24% (for both 2010 and 2011).

Note:  The SSWB was $106,800 for both 2010 and 2011.  It is scheduled to rise to $110,100 for 2012.

Example:

Employer A has misclassified several workers whose 2010 compensation totaled $400,000, of which $300,000 was below the Social Security Wage Base and $100,000 was above.  If Employer A files Form 8952 in 2011, then the most recently completed tax year is 2010.  In that case:

The 3509(a) tax is computed as:

The VCSP payment made with Form 8952 would be $3,528 (10% of the Section 3509(a) tax.)   If the employer were to pay full employment taxes the cost would be significantly more than the VCSP payment amount.  Therefore, for those who choose to make the reclassification, there will be a substantial savings.

According to IRS instructions, you should start treating the workers as employees at least 60 days after filing Form 8952.

If you believe that you qualify for the new IRS program and are interested in taking advantage of the VCSP, please don’t hesitate to contact us.