On September 21, 2011 the Internal Revenue Service (“IRS”) announced a program expected to allow businesses to resolve past worker classification issues with an eye towards limiting risk and uncertainty. In the past several years, there has been considerable attention paid to the revitalized, and some say manic, efforts to identify and penalize employee misclassification. In other words, state and federal agencies have taken up with a vengeance the charge of finding companies who classify workers as consultants or independent contractors when they might more properly be considered employees eligible for all benefits including unemployment, worker’s compensation and overtime. More recently, companies have also found themselves the target of class action lawsuits by which groups of plaintiffs band together seeking to collect unpaid wages and compensation for overtime.
Against this backdrop, the IRS launched the Voluntary Classification Settlement Program (“VCSP”) whereby businesses can agree that they will going forward treat a group of workers as employees in exchange for significantly reduced tax liability for prior years. The VCSP program is available to many businesses, tax-exempt organizations and government entities that currently treat workers as non-employees or independent contractors. A company interested in taking advantage of the program must apply for consideration and must:
•Consistently have treated the workers at issue as non-employees
•Have filed all required Forms 1099 for the workers for the past three years
•Not currently be under audit by the IRS
•Not currently be under audit by the Department of Labor or a state agency concerning the classification of these workers
The program effectively allows a business to “turn itself in” to the IRS before being audited in order to eliminate the considerably increased risk of coming under IRS scrutiny for misclassification. In order to apply to participate in the program, a company must file an application using Form 8952 at least sixty days before the company plans to start treating the workers as employees. If the business is accepted into the program, a “Closing Agreement” setting out the terms of the settlement must be signed.
Acceptance into the VCSP limits the potentially significant financial burden of unpaid tax liability for prior years along with interest and penalties. The company will pay ten percent of the employment tax liability that may have been due on the compensation paid to the workers, calculated at the reduced rates of Internal Revenue Code §3509(a), for the most recent tax years, with no interest or penalties. Since liability for back taxes can be one of the more significant elements of cost to the business who finds itself under scrutiny for alleged misclassification, this program can result in considerable financial relief.
Businesses should understand however that the program does not give a putative employer any quarter from potential liability under worker’s compensation, wage and hour, benefit or unemployment laws. Nor does it protect a company from private lawsuits by employees or former employees seeking damages in the form of lost wages and benefits.
It is therefore very important for a company to look not only at its potential liability under federal tax law but also at what problems it might face under the myriad of state laws which confront the issue. The IRS determines whether employees are properly classified using a balancing test by which it weighs numerous factors in determining whether a company is exercising sufficient control over a worker to necessitate that the worker be deemed an employee. Under state unemployment, worker’s compensation and wage and hour laws, the tests are different and much more stringent. These tests require that workers be in independently established businesses and working without control and direction by those paying for their services.
For a business who has honestly realized that it may have been classifying workers improperly by mistake or misinformation, the VCSP can offer an alternative to the uncertainty and allow for a “clean slate” moving forward. Businesses interested in pursuing the option of applying for the VCSP should consult with counsel about whether the program is appropriate for them and, if so, how to effectively manage a transition of its workforce from nonemployee to employee in the face of numerous agencies with an interest in the final outcome and significant worker relationship concerns.
Charla Bizios Stevens is a Director and Shareholder in the Employment Law Practice Group at the law firm of McLane, Graf, Raulerson & Middleton, P.A. and the incoming director of the SHRM NH State Council for 2012. Charla can be reached at 603-628-1363 or [email protected]. The McLane Law Firm is the largest law firm in the State of New Hampshire, with offices in Concord, Manchester, Portsmouth and Woburn,