The IRS has posted Frequently Asked Questions (FAQs) to its website explaining its new Voluntary Classification Settlement Program ("VCSP") for worker classification issues. For applications submitted in 2011, a recipient of services from a worker can agree to treat the worker as an employee prospectively and pay a significantly reduced tax amount for prior years. For applications filed in 2011, the payment is one-tenth of 10.68% of wages up to the Social Security wage base, and one-tenth of an additional 3.24% on wages exceeding the Social Security wage base. The payment rate is lower for applications filed in 2012. The FAQs are available at http://www.irs.gov/businesses/small/article/0,,id=246014,00.html.
Background.
Whether a worker performs services as an independent contractor or as an employee has been a continuing point of controversy between putative employers on the one hand and the IRS and state labor agencies on the other. The determination generally depends on whether the recipient of the services has the right to direct and control the worker as to how to perform the services. Such determinations tend to be fact specific and a worker's status is often unclear.
In September 2011, the IRS announced a new program to allow recipients of services to reclassify their workers as employees prospectively and to obtain IRS relief from potential past employment tax liability. Under the VCSP program, the service recipient that reclassifies its workers as employees prospectively will be relieved of all Federal withholding tax liability for past years upon payment of an amount equal to 10% of the withholding tax due for the most recently concluded tax year. IRS Announcement 2011-64.
Eligibility and Procedures.
To be eligible to participate in the VCSP, the service recipient must have treated all workers in the same class (e.g. drywall installers) as non-employees for the past three years, and must have filed forms 1099 with respect to each of the workers for each of those years. In addition, the service recipient must not be under an IRS audit, a U.S. Department of Labor audit, or audit by any state agency regarding the classification of the workers.
An eligible service recipient may apply to participate in the program by submitting a VCSP Application (Form 8952) to the IRS Service Center in Ogden, Utah. The form includes a calculation of the closing agreement amount. No payment is required with the application. The FAQs advise that the IRS will review the application and contact the service recipient to confirm the amount of the payment and to enter into a closing agreement.
Calculation of the Closing Agreement Amount.
The closing agreement amount is based on tax rates used to settle employment tax disputes under Code Section 3509. Under that provision, the Federal income tax withholding tax rate is fixed at 1.5% of compensation, and the employee portion of the Social Security tax is reduced to 20% of the otherwise applicable rate. The resulting tax rate is 10.68% on compensation up to the Social Security wage base for 2010 (the rate used for VCSP applications filed in 2011) and 10.28% on compensation up to the Social Security wage base for 2011 (the rate used for VCSP applications filed in 2012). Compensation in excess of the Social Security wage base is subject to an additional tax of 3.24%. Under the VCSP Program, the closing agreement payment is 10% of the rate determined under Section 3509 (or 1.068% of compensation up to the Social Security wage base for applications filed in 2011).
Example.
A service recipient paid $1,500,000 to workers that are included in a VCSP application in 2011. All of the workers were paid at or below the Social Security wage base ($106,800 for 2010). Under Code Section 3509, the applicable federal withholding tax would be $160,200 (10.68% of $1,500,000). Under the VCSP, the service recipient would pay the IRS a closing agreement payment of $16,020 (10% of $160,200).
Effect of Closing Agreement.
If the IRS accepts the VCSP application, it will offer a closing agreement to the service recipient. The closing agreement will provide that the service recipient will treat the subject workers as employees prospectively. The closing agreement will require the service provider to pay the closing agreement amount, without interest or penalties. The service provider must also agree to a three-year extension of the period of limitations on employment tax assessment for the next three years (i.e. to extend the statute of limitations from three years to six). The IRS will agree that the employees covered by the closing agreement will not be subject to a worker classification audit for any prior year.
Other Considerations.
The VCSP is not binding on any state agency with authority to audit the classification of the workers under income tax withholding, workers' compensation, unemployment compensation or similar statutes. The VCSP should be viewed in context on the IRS' other major worker classification settlement program. The IRS launched its Classification Settlement Program ("CSP") in 1996. The CSP program is used only when the IRS raises a worker classification issue on audit. Under the CSP program, a service recipient may enter into a closing agreement to classify workers as employees prospectively if the service recipient agrees to pay an amount equal to one-year's employment taxes, had a reasonable basis to treat the worker as a non-employee and meets certain other requirements.
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