IRS Introduces Partial Amnesty Program for Independent Contractor Misclassification
On September 21, 2011 the Internal Revenue Service introduced the Voluntary Worker Classification Settlement Program that offers employers the opportunity to gain certainty regarding potential past federal tax liability associated with misclassifying workers as independent contractors. The Program allows employers to voluntarily reclassify workers that were improperly classified as independent contractors into employees and pay a minimal payment (federal payroll taxes, interest and penalties) to cover past federal payroll tax obligations for the contractor-turned-employee.
To be eligible for the Program, 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.
With the federal and state authorities increasing their enforcement in this area, the primary benefit of this Program is that it allows employers that believe they may have missclassified workers as independent contractors to be assured, by paying the minimal amount to the IRS (10% of the back payroll taxes owed), that they will have not have any further past federal tax liability.
There are, however, significant risks with using this Program. This program is not a complete amnesty program. There are many areas where an employer can be liable when it misclassifies employees as independent contractors other than federal payroll taxes. This Program only provides relief for federal payroll taxes. Participation in this Program would still leave the employer with potential liability to state taxing agencies, the employer's workers' compensation carrier, and directly to the misclassified worker. In fact, using this Program and then reclassifying the workers as independent contractors may alert the state agencies to the possibility of liability for unpaid state payroll taxes and unemployment contributions. If your workers' compensation carrier becomes aware of the misclassification it can seek payment for past unpaid workers' compensation insurance premiums under the theory that the workers should have been on the payroll used to calculate the amount of the premiums. The reclassification of the workers may also alert them to potential recovery on a variety of issues, including but not limited to unpaid overtime, missed meal and rest breaks and unpaid employee benefits that they did not receive during the time period they were misclassified (such as retirement/pension benefits, stock options, health insurance, and vacation). Moreover, using this Program may be seen as an admission that, in fact, the workers were not independent contractors, thereby making it easier for the state agencies and individual employees to pursue these potential damages. Finally, the Program includes a provision whereby the employer is subject to future payroll tax audits from the IRS for a six year period as opposed to the normal three year statute of limitations.
Although the Voluntary Worker Classification Settlement Program offers certainty regarding past federal taxes, use of the Program could lead to other issues. We recommend that employers think carefully about the risks to their workforce before using this Program and consult with competent attorneys and/or tax advisors before doing so.