IRS Program May Limit Federal Tax Liability for Employee Misclassification

Whether a worker should be classified as an employee or independent contractor can be uncertain, and the standards for making such a determination can be different under the various tests used by the IRS, the U.S. Department of Labor (DOL), and state agencies.

The Internal Revenue Service has instituted the Voluntary Classification Settlement Program (VCSP), which provides employers the opportunity to voluntarily reclassify workers as employees with limited federal employment tax liability for misclassification. It is important to note that this IRS program does not release employers from state law liabilities such as unemployment and workers’ compensation.
Under the VCSP, employers pay 10 percent of the employment tax liability that may have been due on compensation paid to the reclassified workers for the most recent tax year, do not have to pay interest or penalties on the liability, and are not subject to an audit regarding the reclassified workers for prior years. However, the period of limitations on assessment of employment taxes is extended from three years to six years beginning after the date on which the employer enters into an agreement under the VCSP. All workers in the same class must also be reclassified.
To be eligible for the VCSP an employer must have consistently treated the “independent contractors” as non-employees; filed all required Forms 1099 for the workers for the previous three years; and not currently be under examination by the IRS, the DOL, or a state agency.
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This opportunity comes at a time when federal and state agencies are increasing scrutiny of independent contractor classifications. Last year, the DOL collected over $4 million in back wages and overtime penalties resulting from misclassifications. And, the DOL is seeking agreements with state agencies to join in its initiative against misclassification. So far, 11 states, including Colorado, have signed up.