Is your company considering reclassifying certain workers, but hesitant because it is worried about triggering a federal employment tax audit or not having consistently filed Form 1099s for those workers in the past? If you answered yes, then the Internal Revenue Service’s (IRS’s) Temporary Expanded Voluntary Classification Settlement Program (Temporary VCSP) may be of interest to you.
What is the Temporary VCSP?
The Temporary VCSP is one of a handful of federal employment tax relief options for companies that are concerned about federal employment tax liability for misclassifying workers as independent contractors. The Temporary VCSP is a voluntary program for taxpayers who are not currently under an employment tax audit. In exchange for partial relief from federal employment taxes, the program allows taxpayers to voluntarily reclassify workers prospectively who had been treated as independent contractors. The Temporary VCSP was established in December of 2012 and, according to IRS Announcement 2012-46, is available only through June 30, 2013. The Temporary VCSP is an expansion of the IRS Voluntary Classification Settlement Program (VCSP), which, according to IRS Announcement 2012-45, was established in September of 2011 and subsequently revised in December of 2012.
How does the Temporary VCSP Differ from Other Employment Tax Relief Options?
Unlike many of the other federal employment tax relief options, including the VCSP, the Temporary VCSP does not require taxpayers to have filed Form1099s for the affected workers. To participate in the Temporary VCSP, the taxpayer must have consistently treated as non-employees the workers proposed for reclassification, meet certain eligibility requirements, apply on or before June 30, 2013, and enter into a closing agreement with the IRS. In addition, once eligible to participate, a taxpayer must furnish to the workers and electronically file all required Form 1099s for the previous three years.
General Eligibility Requirements
Taxpayers are not eligible to participate in the Temporary VCSP if they are currently under an employment tax audit by the IRS or currently under audit concerning the classification of workers by the U.S. Department of Labor (DOL) or by a state government agency. For this purpose, a member of an “affiliated group” within the meaning of Code Section 1504(a) is considered to be under an employment tax audit if any member of the affiliated group is under an employment tax audit. A taxpayer who was previously audited by the IRS or the DOL for worker classification issues will only be eligible if the taxpayer has complied with the results of that audit and is not currently contesting the classification in court.
Applying for Temporary VCSP
To participate in the Temporary VCSP, a taxpayer must apply on or before June 30, 2013 using Form 8952, Application for Voluntary Classification Settlement Program. Note that there are special instructions and modifications to Form 8952 for Temporary VCSP applications because this is the same form that is used to apply to participate in the VCSP. The application should be filed at least 60 days prior to the date that the taxpayer wants to begin treating affected workers as employees. The IRS will contact the taxpayer or the taxpayer’s authorized representative after reviewing the application and verifying the taxpayer’s eligibility. Taxpayers who are accepted into the Temporary VCSP enter into a closing agreement to finalize the terms of the Temporary VCSP. At that time they are required to make full and complete payment of any amount due under the closing agreement and certify that they have furnished Form 1099s to the affected workers and electronically filed all required Form 1099s for the prior three years with respect to those workers being reclassified. Taxpayers are not required to agree to extend the limitation period on assessment of employment taxes as part of the closing agreement with the IRS.
Temporary VCSP Agreements
A taxpayer that applies for and is accepted into the Temporary VCSP agrees to prospectively treat a class or classes of workers as employees for future tax periods. In exchange,
(1) the taxpayer must pay 25% of the employment tax liability that would have been due on compensation paid to the affected workers for the most recent tax year, calculated under the reduced rates of Code Section 3509(b);
(2) the taxpayer must pay a reduced, but graduated penalty for unfiled Form 1099s for the previous three years for the workers being reclassified (based on the number of required Form 1099s that were not filed); and
(3) the taxpayer will not be subject to an employment tax audit with respect to the reclassified workers for prior years.
For the Temporary VCSP applications filed this year, the most recently closed tax year will be 2012. For 2012, the effective tax rate under Section 3509(b) is 12.91% (for compensation up to the Social Security wage base) and 5.03% (for compensation above the Social Security wage base).
Taxpayer Relief Options After June 30
If the IRS does not extend the Temporary VCSP program, after June 30, 2013, taxpayers may participate in the VCSP if in the prior three years they have consistently treated as independent contractors the workers they seek to reclassify and have filed all required Form 1099s for those workers for those years. Under the VCSP, the taxpayer will pay only 10% of the employment tax liability for the workers who the taxpayer wishes to reclassify prospectively, calculated under the reduced rates of Section 3509(a) and interest and penalties will be waived. For 2012, the effective tax rate under Section 3509(a) is 10.28% (for compensation up to the Social Security wage base) and 3.24% (for compensation above the Social Security wage base). The eligibility requirements and process described above for the Temporary VCSP generally apply to VCSP applications.
Important Frequently Asked Questions
The IRS has posted 24 frequently asked questions about the Temporary VCSP and VCSP on its website. In the Q&As, the IRS states that:
By signing a Temporary VCSP (or VCSP) closing agreement, the taxpayer is not admitting any liability or wrongdoing for past periods. The Temporary VCSP (or VCSP) concerns future years only. The IRS is not making any determination with regard to prior years and the taxpayer is not making any representation as to the workers’ proper status for prior years for federal employment tax purposes.
The IRS will not share data on Temporary VCSP (or VCSP) applicants with the DOL and state agencies.
Applying to, and not qualifying for, the Temporary VCSP (or VCSP) will not automatically trigger an audit.
Taxpayers are permitted to apply to the Temporary VCSP (or VCSP) even after the IRS contacts the taxpayer with respect to a worker’s SS-8 determination letter request.
Final Word of Caution
Participation in the Temporary VCSP or VCSP may expose employers to a host of other legal consequences because these programs are limited to federal employment taxes and do not address any other issues, such as eligibility to participate in an employer’s employee benefit plans, state taxes, or other employment law misclassification concerns. For that reason and because there may be alternatives to the Temporary VCSP or VCSP to reduce or eliminate federal employment tax exposure, employers should weigh carefully all the pros and cons of participating in either program. For a detailed discussion of these alternatives, see “IRS Worker Classification Audits—Risks and Relief Options.”
Vicki M. Nielsen is of counsel in the Washington, D.C. office of Ogletree Deakins.