IRS Creates Voluntary Settlement Program

Posted on Fri, Oct 28, 2011

In September, the Internal Revenue Service (IRS) launched a new program to offer some employers partial relief from federal employment taxes. The program is available to those employers who currently treat their workers, or a class or group of workers, as independent contractors or other nonemployees.

Through the?Voluntary Classification Settlement Program (VCSP), eligible employers can obtain significant relief from past federal payroll taxes (and penalties and interest) if the employers voluntarily reclassify independent contractors as employees, and treat those misclassified workers as employees for future tax periods.

Proper classification of workers can be difficult because different agencies apply different tests to determine whether the worker is an independent contractor. Improper classification of a worker as an independent contractor can lead to substantial financial damages for the employer, including back taxes, penalties and interest.

The IRS finds wrongful classification in up to 90 percent of firms audited, and estimates the employment taxes not collected because of misclassification at $35 billion per year. The IRS, in conjunction with the federal Department of Labor (DOL), has increased efforts to stop worker misclassification, and the agencies have agreed to share information relating to worker classification issues.

This past year, the IRS announced a three-year plan to increase audits of independent contractors, and the DOL also stepped up enforcement efforts, asking for $15,223,000 and 107 employees for an additional 3,250 misclassification investigations in 2012.

To be eligible for the VCSP, the company must have:

  • Consistently have treated workers in the past as nonemployees

  • Filed all required 1099 tax forms for the workers for the previous three years

  • Not be under an IRS audit

  • Not be under an audit by the Department of Labor (DOL) or any state agency relating to the proper classification of these workers


The program allows employers to get into compliance by making a “minimal” payment covering past payroll tax obligations, rather than being subjected to a potential audit. According to the IRS, employers accepted into the program will pay an amount effectively equaling just over one percent of the wages paid to the reclassified worker for the past year. No interest or penalties will be owed, and the employers will not be audited on payroll taxes related to these workers for prior years.

Given this increased enforcement, companies may want to consider the new settlement initiative to address potential federal tax liability. However, reclassification may have other consequences.

For example, wages and penalties could potentially be owed for wage and hour violations resulting from the misclassification, such as missed meal and rest periods or overtime.? Thus, employers should seek legal counsel prior to deciding to enter into the new IRS settlement program.

Copyright: HRC/CalChamber

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