Employers Must Proceed with Caution When Considering Applying for the IRS’ New Voluntary Compliance Program for “Misclassified” Employees
The Internal Revenue Service (“IRS”) recently announced a new voluntary compliance program which provides employers the opportunity to prospectively reclassify as employees those workers who the employer had incorrectly classified as independent contractors in previous tax years. To encourage this voluntary reclassification program, the IRS offers generous settlement terms and, according to the IRS, provides audit relief for previous years. Before applying, however, employers must carefully weigh the risks associated with the new voluntary compliance program against the potential federal tax benefits the IRS is offering for participants of the program.
Am I Eligible to Participate?
To be eligible under the new program employers must meet all of the following requirements:
1. The employer must have consistently treated the workers in the past as nonemployees;
2. The employer must have filed all required Forms 1099 for the workers for the previous three years;
3. The employer must not currently be under audit by the IRS; and
4. The employer must not currently be under audit by the Department of Labor (“DOL”) or any state agency concerning the classification of these workers.
It is important to note that an employer who was previously audited by the IRS or the DOL concerning the classification of the workers will only be eligible if the taxpayer has complied with the results of that audit.
How Do I Participate?
To participate in the IRS’ new voluntary compliance program, employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before the employers wish to begin treating the workers as employees. The IRS will then contact the employer to complete the process once it has reviewed the application and verified the employer’s eligibility. Interestingly, the IRS retains discretion whether to accept an employer’s application for the program. Employers whose application has been accepted will enter into a closing agreement with the IRS finalizing the terms of the employer’s participation in the program and will make full and complete payment of any amount due under the closing agreement.
Benefits of Participating
In exchange for being accepted into the program, employers who “participate” in the voluntary compliance program will agree to prospectively treat the class of workers as employees for future tax periods. Additionally, the employer:
1. Will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year;
2. Will not be liable for any interest and penalties on the liability; and
3. Will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years.
However, an employer participating in the program will agree to extend the statute of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the employer has agreed under the closing agreement to begin treating the workers as employees.
Potential Risks to the Employer
While the benefits of the voluntary compliance program are attractive to employers, employers should be wary of the potential risks associated with participating in the program. For instance, the IRS maintains complete discretion to deny an employer’s application under the new program. As such, if an employer submits an application that the IRS denies, the employer will be denied the benefits of the program and will also identify itself to the IRS as having workers who the employer believes to be misclassified, and potentially subject itself to further investigation by the IRS. This could lead not only to increased burden and expense on behalf of the employer, but also potential tax liability for those misclassified workers.
According to the IRS, the program only offers protection from the IRS, not the DOL or any other applicable state tax or wage and hour agencies. Further, the program does not preclude the IRS from sharing information with other government agencies. Therefore, nothing under the law precludes the DOL or another state agency from pursuing claims based on the same employee misclassification. In fact, the IRS and the DOL have entered into a Memorandum of Understanding (“MOU”), whereby the IRS and DOL have agreed to share information and coordinate law enforcement efforts to ensure all workers are properly classified and to end the practice of misclassifying employees. Many state employment agencies are also signatories to the MOU, and Leech Tishman expects other states will soon follow. This sharing of information between the IRS, DOL, and other state agencies under the MOU can potentially lead to unpaid overtime liability for program applicants under the Fair Labor Standards Act and other state wage payment laws.
Finally, to be accepted to the program, the employer must agree to extend the statute of limitations on the assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the employer has agreed under the closing agreement to begin treating the workers as employees. It is important to note that this extended statute of limitations under the new program is not limited to employee misclassification issues, but will allow the IRS to review a participating employer’s entire employment tax compliance during the extended period.
Therefore, an employer should carefully consider the potential risks of applying for the IRS’ voluntary compliance program and review any application for the program before submitting it to the IRS and potentially subjecting itself to increased scrutiny and potential liability from federal and state government agencies.
Leech Tishman’s Employment Practice Group has experience handling matters with the IRS, DOL, and other state and local tax and employment agencies and is willing to advise you regarding participation in the IRS’ voluntary compliance program.
Please feel free to contact Leech Tishman with any questions about the IRS’ new voluntary compliance program for “misclassified” workers or for assistance with evaluating the program’s risks as they relate to your organization.
Leech Tishman’s Employment Practice Group has extensive experience advising employers on the proper classification of their workforces in order to comply with IRS, DOL, and other state and local tax and employment agency regulations. We are able to assist with any worker classification questions.
Leech Tishman is a firm dedicated to providing full-service commercial legal services to individuals, businesses, and institutions. We combine a deep understanding of our clients’ and their businesses with skilled legal counsel to find solutions. We offer legal services in alternative dispute resolution, bankruptcy & creditors’ rights, construction, corporate, employment, energy, environmental, safety & toxic torts, estates & trusts, government relations, insurance coverage & corporate risk mitigation, litigation, real estate, and taxation. For more information call 412.261.1600 or visit www.leechtishman.com.