What can happen if a business misclassifies some of its workers?
Businesses that improperly classify workers as independent contractors instead of employees can incur substantial amounts in additional taxes and penalties as a result of that misclassification. The Trust Fund recovery penalty may apply if federal income tax, social security tax, and Medicare tax that must be withheld are not withheld, or are either not deposited or paid. This penalty may apply to the responsible person if these unpaid taxes cannot be immediately collected from the employer or business. Furthermore, the Trust Fund Recovery penalty may be imposed on all persons who are determined by the IRS to be responsible for collecting, accounting for, and paying over these taxes and who act willfully in not doing so.
Who a responsible person is, and what we mean with the word “willfully?
A responsible person can be an officer or employee of a corporation, a partner or employee of a partnership, an accountant, a volunteer director or trustee, or an employee of a sole proprietorship. A responsible person also may include someone who signs checks for the business or otherwise has authority to cause suspending of business funds. Willfully means voluntarily, consciously, and intentionally. A responsible person acts willfully if the person knows the required actions are not taking place. More information regarding the trust fund recovery penalty can be found in Publication 15 Circular E, Employer’s Tax Guide.
Section 530 Relief
There is relief available for some taxpayers. First, Section 530 provides businesses with relief from federal employment tax obligations if certain requirements are met. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker.
Do You Qualify for Relief Under Section 530
To get this relief you must file all required federal tax returns, including information returns on a basis consistent with your treatment of the worker. IRS publication 1976, Do You Qualify for Relief Under Section 530, provides additional information on this issue. Next we will discuss Section 3509 rates. If you treated an employee as a nonemployee, Section 3509 provides reduced rates for the employee’s share of FICA taxes and the federal income tax that should have been withheld. Section 3509 does not provide relief for the employer’s share of FICA taxes. The applicable rates depend on whether you filed required forms 1099. See Publication 15, Circular E for additional information.
The IRS classification settlement program, or CSP
The IRS classification settlement program, or CSP, establishes procedures that will allow businesses and the IRS to resolve worker classification cases as early in the course of an exam as possible, thereby reducing taxpayer burden. CSP agreements are closing agreements that bind the service and the taxpayer to prospective tax treatment for future tax periods. If the business meets the CSP qualification, it may be entitled to a reduced amount of tax. Note that the classification settlement program, CSP, is available in an audit setting. For taxpayers that are not under audit, there’s a different program available. It’s called the voluntary classification settlement program or VCSP.
The voluntary classification settlement program or VCSP
As the name indicates, the VCSP is a voluntary program that allows taxpayers to reclassify their workers as employees for future tax periods for federal employment tax purposes and obtain partial relief from federal employment taxes. This is important, because one of the biggest tax issues facing companies today is determining whether their workers are employees or independent contractors. This decision has ramifications to the businesses well beyond the initial determination. The VCSP process is simple.
Participate in the VCSP
To participate in the VCSP, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP program using Form 8952, Application for Voluntary Classification Settlement Program, and if accepted, enter into a closing agreement with the IRS. Rebecca, what else can you tell us about the VCSP? It should also be noted that exempt organizations and government entities may participate in VCSP as long as they meet all of the eligibility requirements. Lastly, a taxpayer that was previously audited by the IRS or the Department of Labor concerning the classification of the workers, will only be eligible if the taxpayer has complied with the results of that audit, and is not currently contesting the worker classification in court.
Form 8952, Application for Voluntary Classification Settlement Program
First, the application Form 8952, Application for Voluntary Classification Settlement Program, should be filed at least 60 days before the date the taxpayer wants to begin treating their workers as employees. There are also new requirements mandating that the taxpayer include a list of names and social security numbers for the workers identified for the worker classification. The IRS will review the application and verify the taxpayer’s eligibility. As part of the agreement, taxpayers receive audit protection from the IRS employment tax audits concerning the class of workers covered by the VCSP agreement for the past years. However, the audit protection does not extend to other issues, if present.
In return, taxpayers agree to prospectively treat a class or classes of workers as employees and pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year determined under the reduced rates of Section 3509(a) of the Internal Revenue Code. The payment works out to just over 1% of the amount paid to these workers for the most recently completed tax year. In addition, businesses will not be liable for any interest and penalties on the amount due. We believe this is very attractive. For additional guidance, please refer to IRS announcement 2012-45 and the IRS website. Those are the highlights of the voluntary classification settlement program.
Eligibility for Voluntary Classification Settlement Program
To be eligible for the VCSP, one of the criteria is that the taxpayer; A, must have consistently treated the workers as nonemployees and must have filed all required forms 1099 for the workers to be reclassified for the previous five years; B, is currently under audit concerning the classification of workers by the Department of Labor or by a state government agency; C, is not currently under employment tax audit by the IRS; D, is not an exempt organization.