New Settlement Program for Misclassified Workers Provides Employers with a Unique Opportunity
The Internal Revenue Service (the "IRS") has recently announced the Voluntary Classification Settlement Program (the "VCSP") for employers that have misclassified workers as independent contractors. The VCSP allows employers to reclassify some or all of their workers as employees for future tax periods and pay only a fraction of the tax applicable to such misclassification.
In order to be eligible for the VCSP, an employer must (i) have consistently treated the workers being reclassified as independent contractors; (ii) have filed any required Forms 1099 with respect to each such worker for the past three years; and (iii) not be currently under audit by the IRS, the Department of Labor or any state agency regarding the classification of the workers. An employer that was previously audited by the IRS or the Department of Labor concerning classification of the workers may be eligible for the VCSP if it has complied with the results of such audit.
An employer that participates in the VCSP will pay 10% of the employment tax liability on compensation paid to the reclassified workers for only the most recent full tax year. No amount would be due with respect to the reclassified workers for years prior to such year and there will be no interest or penalties with respect to any reclassified work. Further, the 10% tax is calculated based on the substantially reduced rates afforded by Internal Revenue Code Section 3509. Under Code Section 3509, the tax rate on compensation up to the Social Security wage base is 10.68% for 2010 (which applies if the application to participate in the VCSP is filed in 2011) and 10.28% in 2011 (which applies if the application to participate in the VCSP is filed in 2012). The rate is 3.24% for amounts over the Social Security wage based for each year. An employer participating in the VCSP pays only 10% of the amount calculated pursuant to Code Section 3509.
For example, an employer that applies for the VCSP in 2011 paid compensation of $1,000,000 in 2010 to workers that are reclassified as employees under the VCSP. All such workers were compensated at or below the Social Security wage base. The tax computed under Code Section 3509 would be $106,800 (10.68% of $1,000,000). Under the VCSP, the employer's payment would be $10,680 (10% of $106,800). This payment would be required only with respect to the most recent full tax year.
Once an employer chooses to reclassify workers as employees pursuant to the VCSP, all workers in the same class must be treated as employees for future tax periods for employment tax purposes. In addition, the employer must extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date the employer has agreed to begin treating the workers as employees.
Please note that worker classification may have significant implications for employee benefit plan eligibility and coverage, and has led to claims by reclassified workers seeking benefits that would have accrued but for their misclassification as independent contractors ineligible to participate in the employer's benefit plans. Accordingly, in conjunction with an evaluation of whether reclassification is appropriate under the VCSP, employers should also review their employee benefit plans to ensure that plan provisions (i) guard against potential liability for benefit accruals based on worker misclassification, and (ii) clearly define the classes of employees who are eligible and ineligible to participate in the applicable benefit plans.