On Tuesday, the IRS made significant changes to its Voluntary Classification Settlement Program (VCSP). In Announcement 2012-46, in effect until June 30, 2013, the IRS is temporarily permitting employers who have not filed Forms 1099 for their workers to participate in the program by paying a larger amount of past due tax than would be due under the normal VCSP. In Announcement 2012-45, which modifies and supersedes Announcement 2011-64, the IRS says it is liberalizing a few of the program’s rules.
In September 2011, the IRS announced a new program under which employers can reclassify independent contractors as employees and limit the resulting federal payroll taxes for their most recent tax year, plus avoid related penalties and interest for prior years (Announcement 2011-64).
To participate in the VCSP, as originally announced, employers had to submit an application and agree to prospectively treat their workers or a class or group of workers as employees for federal employment tax purposes in future tax periods. Employers also were required to agree to extend the period of limitation on assessment of employment taxes for three years for each of the three calendar years beginning after the date of the agreement.
In return, employers paid 10% of the employment tax liability otherwise due for the most recent tax year, which was not subject to interest or penalties. In addition, the IRS agreed not to conduct an employment tax audit with respect to the employer’s worker classification for prior years. The employment tax liability for the most recent year was determined under the reduced rates of Sec. 3509, which provides that for failure to deduct and withhold taxes arising from a worker misclassification, the employer’s liability for the employee’s portion of FICA tax is limited to 20% of the normal employee FICA tax.
To be eligible for the program, employers could not currently be under audit by the IRS for any issue, or be under audit by the U.S. Labor Department or a state agency concerning worker classification. Employers whose worker classification had been previously audited must have complied with results of the audit. Also, employers must have consistently treated workers as nonemployees, for whom they must have filed all required Forms 1099 for the previous three years.
Liberalized VCSP rules
After a year of experience with the program and in response to feedback from taxpayers and their representatives, the IRS is making the following changes or clarifications to the VCSP:
- A taxpayer under IRS audit, other than an employment tax audit, is now eligible to participate.
- A taxpayer is no longer required to agree to extend the limitation period on employment tax assessment as part of the VCSP closing agreement with the IRS.
The IRS reiterated the current eligibility requirement that a taxpayer that is a member of an affiliated group under Sec. 1504(a) is not eligible to participate in the VCSP if any member of the affiliated group is under employment tax audit. The IRS also emphasized that a taxpayer is not eligible to participate in the VCSP if the taxpayer is contesting in court the classification of the class or classes of workers from a previous IRS or Labor Department audit.
Temporary expansion of VCSP eligibility
In response to requests from taxpayers that requested VCSP relief but did not qualify for the VCSP program because they had not filed Forms 1099 for their workers, the IRS announced a temporary program for those taxpayers (Announcement 2012-46). To participate, taxpayers must submit applications to the IRS by June 30, 2013. The temporary eligibility expansion is available for taxpayers who want to voluntarily change the classification of workers from independent contractors to prospectively treat the workers as employees.
To be eligible to participate in the temporary expansion, the taxpayer must furnish to the workers and electronically file all required Forms 1099, consistent with the nonemployee treatment, for the workers being reclassified for the previous three years, before executing the temporary eligibility closing agreement with the IRS.
If the IRS approves a taxpayer’s application, the taxpayer will pay:
- 25% (compared with 10% in the regular VCSP) of the employment tax liability that would have been due on compensation paid to the workers being reclassified for the most recent tax year if those workers were classified as employees for that year, determined under the reduced rates of Sec. 3509(b); and
- A reduced penalty for unfiled Forms 1099 for the previous three years for the workers being reclassified.
Furthermore, approved taxpayers will not be liable for any interest and penalties on the liability and will not be subject to an employment tax audit for the worker classification of the class or classes of workers for prior years.
The taxpayer must certify in the VCSP temporary eligibility expansion closing agreement that it has furnished to the workers and has electronically filed all required Forms 1099 for the previous three years for the workers being reclassified.