Worker Classification: Voluntary Classification Settlement Program vs. Section 530 Relief

July 14, 2013

The world of worker classification is still fraught with great uncertainty. The distinguishing factors between an employee and an independent contractor are different between the federal and state agencies. Thus, it is possible for a worker to be considered an independent contractor by one agency, but be deemed an employee by another. Because companies that choose to reclassify their workers to employee status can face large taxes due, many adopt the strategy of closing one’s eyes and hoping for the best.

In an attempt to address the issue and to encourage companies to take a hard look at the classification of their workers, the Internal Revenue Service introduced its Voluntary Classification Settlement Program (VCSP) in 2011, and modestly liberalized it in 2012. The benefit of this program is that the tax cost is very low – 1% of the reclassified worker’s compensation, with no interest or penalties. However, this program is not binding to any states, nor does it provide any clarity to existing laws.

To enter this program, the following criteria must be met:

  1. The employer has treated all workers consistently – the individual has never been classified as an employee, and workers who hold a substantially similar position have also never been classified as employees.
  2. The employer has filed a Form 1099 for each misclassified worker for each of the past three years.
  3. The employer cannot be presently under an employment tax examination by the IRS, and is not presently under examination by the Department of Labor or any state government agency with respect to the worker classification issue.

The alternative relief is found under Section 530, which prevents the IRS from retroactively reclassifying workers if all of the following criteria are met:

  1. Consistently treated subject workers and workers in similar job situations as independent contractors.
  2. Issued a form 1099-MISC to each contractor in accordance with the form’s reporting requirements
  3. Had a reasonable basis for the treatment of the worker as an independent contractor:
  • Longstanding practice in your industry
  • Prior IRS audit with no assessment for employment taxes
  • Court case in your favor with similar fact pattern
  • Relied on professional advice

It is interesting to note that the first two requirements of the VCSP and of Section 530 are the same. Therefore, meeting the reasonable basis criterion under Section 530 will accomplish the same protection the VCSP provides, without the need to reclassify and without the need to file anything with the IRS. Because the IRS shares information with other federal and state agencies, it is possible a VCSP filing will trigger a state employment tax examination.

The VCSP is a step in the right direction, but until states in which you have workers are either on board or have a similar relief plan, extreme caution should be used if seeking relief under the VCSP.

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