In recent years, the Internal Revenue Service (IRS) has made a big push to get employers to properly classify employees—they’ve stepped up their audits of organizations who may have improperly classified workers as independent contractors (workers who should have been classified as employees all along).
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What should employers do when they realize that perhaps some of their independent contractors actually should be classified as employees? Are there steps that can be taken to minimize the penalties involved during the transition?
Thankfully, the answer is yes. The IRS has a program called the Voluntary Classification Settlement Program (VCSP) that allows employers to voluntarily reclassify independent contractors as employees—all while minimizing the payout obligations of employers for past-owed taxes on those same employees. HR managers—especially those directly involved in payroll—can assist in this process by understanding the IRS requirements to participate. HR managers can also be instrumental in assisting the organization in internal audits to determine whether or not there may be misclassifications and to get those remedied before an official IRS audit occurs.
VCSP 101
If your organization has discovered that some employees have been incorrectly classified as independent contractors, you may want to consider utilizing the VCSP. It allows an employer to reclassify the employees correctly for the future while simultaneously drastically reducing the back employment taxes owed. It also gives the organization some measure of assurance that it will not have to fear an audit for those same employees since it is remedying the situation officially through the IRS.
According to the IRS website, here are the eligibility requirements for an organization (taxpayer) to participate:
- The organization’s classification of the workers (as independent contractors) over the past 3 years must have been consistent, including the filing of their 1099 forms.[i]
- The organization cannot participate if it is currently under an IRS employment tax audit, nor can it currently be under a classification audit from the Department of Labor (DOL) or any state government group. Additionally, if the organization has been previously audited by the IRS or the DOL on this topic, it is eligible only if it has already complied with the former audit results AND is not contesting that classification audit result.
To participate in the VCSP, the organization must agree to classify the workers as employees going forward. The organization will, in turn, be liable to pay a reduced employment tax for the affected employees for the most recent tax year. It’s a significant reduction—the organization is liable for only 10% of the employment tax, and that amount is based on a reduced rate table. In addition, the organization will not be liable for interest and penalties on the back taxes owed for those employees.
Clearly, these are all significant benefits to any employer that finds itself in a situation where it needs to correct the classification of workers from independent contractor to employee. To participate in the VCSP, the first step is to apply using the IRS Form 8952. This application will be reviewed by the IRS to confirm eligibility, and then the process will begin.
*This article does not constitute legal advice. Always consult legal counsel with specific questions.
[i] The eligibility requirements come directly from the IRS page on the topic: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Voluntary-Classification-Settlement-Program.
About Bridget Miller:
Bridget Miller is a business consultant with a specialized MBA in International Economics and Management, which provides a unique perspective on business challenges. She’s been working in the corporate world for over 15 years, with experience across multiple diverse departments including HR, sales, marketing, IT, commercial development, and training.