The IRS has expanded its worker classification settlement program with permanent changes to the eligibility requirements and even broader temporary rules.

The Voluntary Classification Settlement Program (VCSP) was originally unveiled on Sept. 21, 2011, with Announcement 2011-64 and IR-2011-95. It allows employers to voluntarily reclassify independent contractors as employees and pay significantly reduced prior employment taxes (approximately 1% of one year's worth of pay) and no penalties or interest. On Dec. 17, 2012, the IRS issued announcements 2012-45 and 2012-46, which permanently change the general eligibility requirements and offer a temporary expansion to include employers who have not filed all required Forms 1099. The permanent changes to the VCSP will generally:

  • allow employers under audit for nonemployment tax issues to participate,
  • allow taxpayers previously audited by the IRS or DOL to participate as long as they are not contesting worker classification in court,
  • bar taxpayers with affiliated group members under employment tax audit, and
  • remove the requirement that taxpayers agree to extend the statute of limitations in closing agreements.

The VCSP is meant to encourage voluntary compliance with worker classification rules. It is intended for employers who are currently treating a class of workers as independent contractors but want to voluntarily reclassify the workers as employees for federal employment tax purposes going forward.

Permanent changes to eligibility

Employers were previously ineligible for the VCSP if they were under IRS audit, regardless of whether the audit had identified worker classification as an issue. Now employers are eligible for the VCSP if they are under IRS audit as long as the audit is not for employment taxes. An employer is still ineligible for the VCSP if it is currently under a worker classification audit by the Department of Labor (DOL) or a state agency for the class or classes of workers it intends to reclassify as employees.

The IRS has clarified that an employer that is a member of an affiliated group within the meaning of Section 1504(a) (which generally includes corporations with 80% ownership) is ineligible to participate in the VCSP if any member of the affiliated group is under an IRS employment tax audit.

Similar to the original eligibility requirements, an employer that was previously audited by the IRS or DOL concerning worker classification is eligible for VCSP if the employer has complied with the results of the audit. However, the IRS has clarified that the employer is not eligible for VCSP if it is contesting in court the classification of the workers from a previous audit by the IRS or DOL.

Participation in the VCSP previously required employers to sign a closing agreement with the IRS that extended the statute of limitations from three years to six years for the first three calendar years beginning after the closing agreement was signed. The IRS has eliminated this requirement from the VCSP.

In addition to these VCSP eligibility requirements, the employer must:

  • consistently have treated the workers as nonemployees, and
  • have filed all required Forms 1099 for the workers for the previous three years.

Temporary eligibility expansion

To participate in the VCSP, employers must have filed all required Forms 1099 for the workers for the previous three years. The temporary eligibility expansion in Announcement 2012-46 makes a modified VCSP available to employers that would otherwise be eligible for the VCSP but have not filed all required Forms 1099 for the previous three years with respect to the workers to be reclassified. The modified reclassification program is referred to as the VCSP Temporary Eligibility Expansion and is available until June 30, 2013.

Like the VCSP, the VCSP Temporary Eligibility Expansion permits eligible employers to voluntarily reclassify their workers as employees for federal employment tax purposes and obtain certain relief. The payment under the VCSP Temporary Eligibility Expansion is higher than for the VCSP, but the benefits are otherwise the same.

To be eligible for the VCSP Temporary Eligibility Expansion, employers must meet all of the eligibility requirements for the VCSP, including the modified requirements discussed above. They are not, however, required to have filed all required Forms 1099 for the previous three years with respect to the workers to be reclassified.

Before closing the VCSP Temporary Eligibility Expansion agreement with the IRS, the employer must furnish the workers with the appropriate Forms 1099 for the past three years and electronically file the Forms 1099 with the IRS. The IRS will not complete the VCSP Temporary Eligibility Expansion process until the employer has certified that the appropriate forms have been furnished and filed.

Employers apply for the VCSP Temporary Eligibility Expansion by filing Form 8952, Application for Voluntary Classification Settlement Program. This is the same form used for the VCSP, but employers using the VCSP Temporary Eligibility Expansion are required to write "VCSP Temporary Eligibility Expansion" at the top of the form.

To be eligible to participate in the VCSP Temporary Eligibility Expansion, Form 8952 must be filed on or before June 30, 2013.

The rest of the application procedures for the VCSP Temporary Eligibility Expansion are the same as for the VCSP.

Payment requirements

Under the general VCSP, participants are required to pay only 10% of their Section 3509 liability related to the affected workers in the most recent tax year. The liability determination under Section 3509 provides for reduced rates on the prior wages of misclassified workers, equal to 10.28% for 2011 and 2012 (for wages less than the Social Security cap). So employers in the program will generally pay back taxes of only 1.068% of worker pay for 2011 and 2012 (i.e., for applications filed in 2012 and 2013). For wages exceeding the Social Security cap, employers will pay 0.324%.

The required payments under the VCSP Temporary Eligibility Expansion are higher. Employers must pay 25% of their Section 3509 liability for the calendar year proceeding the year in which the Form 8952 is filed. For wages under the Social Security cap, this will result in a rate of 2.67% on 2011 and 2012 wages (i.e., for applications filed in 2012 and 2013).

In addition, employers participating in the VCSP Temporary Eligibility Expansion are required to pay a reduced penalty for unfiled Forms 1099 for the previous three years. Employers will not owe any interest and penalties, and will not be subject to an employment tax audit on the workers for prior years. Payment of the taxes under the program occurs at the time the employer enters into the closing agreement with the IRS.

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