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Reclassifying Independent Contract Workers As Employees?

Jan 27, 2012

Posted by Keith Hall - Are the workers in your business Independent Contractors or are they really Employees, instead?  For most of us it is easier to simply call them independent contractors instead of employees because the presumption is that the paperwork is easier.  No withholding, no payroll taxes, less hassles. 

The problem is that the classification of your workers is not a matter of choice.  You can’t just choose for them to be independent contractors because it is easier.  Your worker’s classification is determined by the underlying facts and circumstances of the working relationship with the key point being who controls the work product.  Who tells the worker when to be at work, how to do the work, who provides the tools to accomplish the work, etc?  This has been a point of contention with the IRS for years, and they seem to be increasing their efforts to find those of us who have not been making the appropriate classification.  If you have inappropriately classified employees as independent contractors and therefore failed to withhold and pay applicable taxes the IRS is most likely looking for you. 

But there is good news.  The IRS has developed The Voluntary Classification Settlement Program (VCSP) in order to provide an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods.  For those of us who weren’t aware of the rules, this is a great chance to get things right, and most likely avoid penalties and interest that might otherwise be due.  The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers.  The program applies to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to prospectively treat the workers as employees.


Taxpayers file an application (Form 8952) to start the process. With acceptance, businesses pay just 10% of the tax computed on favorable rates. There are no penalties or interest for misfiling for past years. There is also audit protection for past years on workers being reclassified.  The most confusing part of this issue is exactly who is an independent contractor and how far back can the IRS go if you have made an error.  The VCSP, according to the IRS, removes the uncertainty for Federal Employment Tax purposes and potentially limits the exposure from previous years.


Easy Process:

Business owners should complete Form 8952, Application for Voluntary Classification Settlement Program, and file 60 days prior to treating workers as employees. At that point, the IRS will review the application and, if eligible, a closing agreement will be prepared by the IRS. Business owners should send payment after the closing agreement is received.


Eligible businesses:

- Must be currently treating workers as nonemployers

- Must have filed 1099s for nonemployees

- Cannot be under audit

- Can be tax-exempt organizations or government entities

- Agree to extend the Statute of Limitations

If you are not sure or you know that you have made an incorrect classification, the VCSP may be a good thing for you.  Have questions? NASE Members can refer questions to our CPAs and small business tax professionals here.

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