Independent contractor or employee?

Take care with IRS amnesty offer

Good news may have arrived recently for employers who have struggled with whether workers employed as independent contractors should really be classified as employees. On Sept. 21, the IRS began an amnesty program called the Voluntary Classification Settlement Program (VCSP), which allows employers who have been misclassifying their workers as independent contractors to come forward, come clean and avoid significant tax deficiencies and penalties.

Employers are generally liable for back payroll taxes when an employee is mistakenly classified as an independent contractor and payroll taxes are not paid to the IRS. In addition, penalties for misclassifying employees can be significant, especially if the IRS determines the employer lacked a reasonable basis for the initial classification. Moreover, penalties may be assessed for the previous three years for each worker misclassified.

The VCSP, however, allows eligible employers to pay, effectively, just over 1 percent of the wages paid to the workers for the previous year only and avoid penalties and deficiencies for prior tax years.

To be eligible for the program, an employer must not be under an audit, must be current with tax filings for the workers involved and must have consistently treated the workers as independent contractors for the previous three years. In exchange for being allowed to participate in the VCSP, the employer must also agree to extend by three years the IRS audit limitations period for each of the next three tax reporting years.

An employer who has been misclassifying workers should come clean, and this clearly is a good time to do it.

But while this issue seems simple, in many cases it isn't. There is no single, bright-line test for determining whether a worker is an independent contractor or an employee. Many well-established factors must be weighed, and ultimately, the amount of control exercised by the employer is determinative.

Employers who are unsure as to whether their workers are misclassified should not take advantage of the amnesty offer simply because it sounds like a good deal. Consider:

  • The VCSP does not apply to liability for state and local taxes (and penalties). If you accept the amnesty offer, you may be liable for these.
  • Reclassified workers can challenge past withholding failures of the employer and collect for Social Security payments the workers have had to pay.
  • In addition, employers could be liable for past unpaid overtime payments to workers who should have been classified as employees initially. Indeed, the IRS just signed a memorandum of understanding with the U.S. Department of Labor, which enforces overtime laws, to share information to combat worker misclassification.
  • Reclassification may affect an employer's retirement and benefit plans as well as workers' compensation.

While the VCSP offers many positive incentives, the decision to reclassify workers should be made only after consulting with an attorney. For more information about the settlement program, contact an attorney at Nicola, Gudbranson & Cooper.

—James H. Grove
grove@nicola.com