In Announcement 2011-64, the IRS developed a new program to permit employer/ taxpayers to voluntarily reclassify workers as employees for employment tax purposes. And the penalty for compliance: a mere 10% of the employment tax liability that would have been due for the last year (plus the promise to the classify the individuals as employees going forward)!
Recall the importance of how an employer classifies its workers. Subject to a base limit, the compensation of every employee is subject to FICA taxes (commonly called social security taxes). Further, IRC Section 3102(a) requires employers to withhold FICA taxes from an employee’s pay. If the employer fails to withhold the tax, it is still liable for payment of the tax. In addition, the employer must also pay a matching FICA tax equal to the employee portion of the tax. Lastly, a federal unemployment tax (FUTA ) is assessed on employers on all “wages” paid in a calendar quarter, although frequently employers never actually pay federal unemployment taxes due to credits they receive for payment of state unemployment taxes. An independent contractor (or self-employed person), on the other hand, pays for his or her own social security in the form of self-employment taxes (SECA). A self-employed person pays an amount equal to the employee portion plus the employer portion of employment taxes.
Who’s an employee and who’s an independent contractor? It comes down to a review of factors, including:
(1) the degree of control exercised by the principal;
(2) which party invests in the work facilities used by the worker;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal’s regular business;
(6) the permanency of the relationship;
(7) whether the worker is paid by the job or by the time;
(8) the relationship the parties believed they were creating; and
(9) the provision of employee benefits.
To be eligible for the program, called the Voluntary Classification Settlement Program (“VCSP”), an employer must: (1) consistently have treated the workers in the past as nonemployees; (2) have filed all required Forms 1099 for the workers for the previous three years; and (3) not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers. No interest or penalties will be due (there will be the 10% employment tax liability for the previous year), and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. The IRS retains discretion whether to accept a taxpayer’s application under the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS.