Time to turn over a new leaf?

For more than four decades, companies have been battling the IRS about the status of workers – are they employees or independent contractors?  In IRS audits where workers’ status is reclassified, the penalties are steep: you pay from 25% to 100% of the full employment tax liability.

Many taxpayers have walked a fine line on this issue.  Now there’s a way to come clean — and pay less.  And because more than one IRS initiative is focusing on employee classification, it’s something to consider.

What are the definitions?

The courts have defined employees as workers over which the business may legally control what must be done AND how it must be done.   Independent contractors are workers over which the business controls only what must be done, not how it is accomplished.  The degree of control may include behavioral control, financial control, and the relationship between the parties.

Who is eligible?

The Voluntary Classification Settlement Program (VCSP) is available only to businesses who are not currently under a related audit by the IRS, the Department of Labor, or the state.  You must have filed all required 1099s for your workers for the past three years.

How does it work?

At least 90 days before you plan to reclassify your employees, you must complete and submit Form 8952.  The IRS will review it and, if you are eligible, they will contact you to enter into the VCSP Closing Agreement.  You sign the agreement and send it back with the payment.   The workers affected (either a specific class of workers, or all of your staff) must then be treated as employees going forward.

What will it cost?

The participating business must pay 10% of employment taxes calculated using the reduced rates of IRC Sec. 3509 for the compensation paid to the workers being reclassified during the most recently closed tax year. Under Section 3509 , the effective tax rate for compensation up to the Social Security wage base is 10.68% in 2010 (10.28% in 2011) and 3.24% for compensation above the Social Security wage base.

For example, imagine you paid $100,000 to a class of workers in 2010, and filed your VCSP application on 10/1/11. None of them earned more than $106,800, the Social Security wage base for 2010.    Using the amount paid to the workers in 2010 (the most recent tax year), you would pay a VCSP assessment of $1,068:  [($100,000 x 10.68%) x 10%].  You will begin treating these workers as employees the first of next year.

Should I do it?

The decision is yours, and you should consult your tax professional.  Just be aware: the IRS is focusing on this issue, and if it’s found during an audit you could pay much more!