In September 2011 the Internal Revenue Service (IRS) announced a new voluntary relief program for worker status termed the voluntary classification settlement program (VCSP). Announcement 2011-64, 2011-41, I.R.B. 503. On December 17, 2012, the IRS modified four aspects of the VCSP, in Announcement 2012-45, and also temporarily expanded the program through June 12, 2013 (the VCSP Temporary Eligibility Expansion) in Announcement 2012-46.
The VCSP allows employers to voluntarily reclassify workers who were treated as independent contractors (ICs) prospectively in exchange for immunity for the past. The prospective voluntary classification is not required to be made for all workers, but must cover all of a class or type of worker. As part of the VCSP, an employer cannot have similarly situated workers who were reclassified as employees while others continue as independent contractors.
There are two primary benefits to the VCSP. First, there are no penalties and no interest, and the payment involved is very nominal. The amount due is calculated using the reduced rates of §3509 of the Internal Revenue Code (IRC), and is based on compensation paid in the most recently closed tax year determined when the VCSP application is filed. For 2012, under IRC §3509, the effective tax rate for compensation up to the Social Security wage base is 10.28 percent, and for compensation above the Social Security wage base it is 3.24 percent. For VCSP applications filed in 2013, the most recently closed tax year will be 2012, and therefore these 2012 rates will apply. The VCSP payment is 10 percent of the IRC §3509 rates. The IRS estimates that the 10 percent payment will equal just over 1 percent of the income the employer paid to its reclassified workers for the prior year.
The second benefit is that the employer and the IRS enter into related to these workers for past years. Therefore participants in the program will relinquish the independent contractor classification prospectively without implicating the past.
One negative aspect to the VCSP is that the employer must agree to extend the period of limitations for assessment of employment taxes. This extension is implemented as part of the VCSP closing agreement with the IRS.
To qualify for the VCSP, the employer must consistently have treated the workers in the past as independent contractors. The worker must have always been paid an as an independent contractor and not have been given the same benefits and same rights given to employees. The employer must have filed all required Forms 1099 for the workers for the previous three years. Finally, the employer may not currently be under audit by the IRS, the Department of Labor, or a state agency concerning the classification of these workers.
To apply for the program, an employer must file Form 8952, Application for VCSP. The IRS asks prospective participants to file the application at least 60 days before the employer wants to begin treating the affected workers as employees. The IRS will review the application and inform the employer if it is accepted into the program. The IRS and the employer will sign a closing agreement and pay the amount due, as calculated in Form 8952, at the time of the closing.
The IRS stated that to date it has received 700 applications covering about 15,000 workers. However, the IRS had stated previously that it was considering changes to remove barriers to entering the program.
Four modifications have been made to the VCSP by Announcement 2012-45, based on taxpayer feedback. First, an employer under an IRS audit can participate in the VCSP as long as the audit is not an employment tax audit. The announcement also eliminates the requirement that an employer agree to extend the statute of limitations on assessment of employment taxes as part of its VCSP closing agreement. The announcement clarifies two other eligibility requirements. An employer is not eligible to participate if it is contesting in court the classification of workers from a previous IRS or Department of Labor audit, or if it is a member of an affiliated group in which any member of the affiliated group is under audit.
The VCSP Temporary Eligibility Expansion permits employers that do not meet all of the conditions for the original VCSP to reclassify workers for federal employment tax purposes. The VCSP Temporary Eligibility Expansion is available to employees who meet all of the conditions to participate in the original VCSP, except that they have not previously filed all required Forms 1099 consistent with non-employee treatment for workers proposed for reclassification. The settlement payment under the original VCSP is 10 percent 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 IRC §3509. The settlement payment under the VCSP Temporary Eligibility Expansion is 25 percent of that amount. In addition, the employer must pay a reduced penalty for unfiled Forms 1099 for the previous three years. As under the VCSP, the employer is not liable for interest and penalties on the employment tax liability and will not be subject to an employment tax audit with respect to worker classification of the class or classes of reclassified workers for prior years.
Employers that wish to participate in the VCSP Temporary Eligibility Expansion must submit an application on or before June 30, 2013 using IRS Form 8952, with the phrase “VCSP Temporary Eligibility Expansion” inserted at the top of the Form. The original VCSP (with the modifications discussed above) continues to be available for employers who have timely filed Forms 1099 for workers it seeks to reclassify.
Employers who have not filed Forms 1099 for non-employee service providers may consider this reclassification opportunity as an alternative to other strategies to achieve compliance with federal tax laws governing employee classification, including bona fide restructuring of the relationship between service providers and service recipients, the use of a third-party employee leasing or staffing company, and voluntary reclassification outside of any government program. Those alternatives can be analyzed using IC Diagnostics™ and other proprietary compliance tools of Pepper’s Independent Contractor Compliance Practice. Taxpayers may also be eligible for a safe harbor from liability from employment taxes under Section 530 of the Revenue Act of 1978. Additional background on these alternatives can be found in Pepper’s Client Alert on minimizing IC misclassification liability.
Whether an employer should participate in the VCSP Program or Temporary Eligibility Expansion requires consideration of a number of factors, including (i) participation in the VCSP only addresses potential employment tax exposure and does not eliminate the potential exposure to other enforcement actions relating to overtime, unemployment taxes, workers compensation premiums and state and local income taxes, and (ii) the risk that reclassified workers will be alerted to the issue and use the reclassification to assert claims before administrative agencies and in private litigation seeking overtime pay, unpaid employee expenses, and/or employee benefits that would have been available to them if previously classified as employees. Neither the VCSP nor the Temporary Eligibility Expansion offers protection from these exposures. It should be remembered that the seminal Microsoft case, Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997), regarding the collateral consequences of reclassification, commenced shortly after Microsoft resolved its employment tax liabilities with the IRS. Consequently, employers must weigh carefully the pros and cons of participating in the VCSP or Temporary Eligibility Expansion.