A constant source of friction between the IRS and taxpayers is over the classification of workers. Are the workers employees or independent contractors? If they are employees, the employer must withhold income and payroll taxes from their wages and pay the employer's share of the applicable payroll taxes. The IRS has developed a new program, the Voluntary Classification Settlement Program (the "VCSP"), that allows employers to prospectively reclassify workers as employees instead of independent contractors or other non-employees. The VCSP provides partial relief from past employment taxes by requiring eligible taxpayers to pay only 10% of the employment tax liability that would otherwise have been due on compensation paid for the most recently closed tax year as determined by reduced rates. According to the IRS, employers accepted into the program will pay an effective amount equal to just over one percent of the wages paid to the reclassified workers for the past year. If a taxpayer chooses to reclassify certain of its workers as employees, it must also reclassify all workers in the same class as employees for employment tax purposes.

A taxpayer is eligible to participate in the program if: i) the taxpayer has consistently treated the workers as non-employees; ii) has filed all required Forms 1099 for the workers for the prior three years; iii) is not currently under audit by the IRS; and iv) is not currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency. A taxpayer that was previously audited by the IRS or Department of Labor concerning the classification of workers will be eligible for the VCSP if the taxpayer has complied with the results of that audit. Exempt organizations and government entities may participate in the VCSP if they satisfy the above requirements and are not undergoing a Form 990 series audit.

A taxpayer who participates in the VCSP will agree to prospectively treat the class of workers as employees and to extend the statute of limitations on employment taxes to six years for the first three years under the VCSP closing agreement. In exchange, the taxpayer will: i) pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year as determined under reduced rates; ii) avoid liability for any interest and penalties on such amount; and iii) avoid any employment tax audit with respect to the classification of the workers for prior years.

To apply for the VCSP, the taxpayer must submit an Application for Voluntary Classification Settlement Program at least 60 days before the taxpayer wants to begin treating the workers as employees. If the IRS accepts the application, the taxpayer will enter into a closing agreement with the IRS to finalize the terms of the VCSP and will simultaneously pay any amount due under the closing agreement.

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