Independent Contractor vs. Employee – IRS throws a bargaining chip into the mix

The IRS has launched a new program that may help employers to resolve past worker classification issues (Independent Contractor vs. Employee) at a relatively low tax cost by voluntarily reclassifying their workers.

As regular readers know, IRS’ attitude on this issue has been less than helpful in the past. Personally, I do not know of even one instance where a client has obtained IRS consent to treat payments to a sub as contract labor. For the last five years, this has been a major area of exposure for clients even when the vast preponderance of evidence was in their favor.

According to our friends at IRS, “the new IRS Voluntary Classification Settlement Program” (a/k/a IRS’ Fresh Start) is designed to increase tax compliance and reduce burden for employers by providing greater certainty for employers, workers and the government,” according to the IRS.

Under the program, eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past, if they prospectively treat workers as employees. The IRS program is available to many organizations, tax-exempt organizations and government entities that now erroneously treat workers as non-employees or independent contractors, and want to reclassify them as employees.

To be eligible, an applicant must:

• Consistently have treated the workers in the past as non-employees.
• Have filed all required Forms 1099 for the workers for the previous three years.
• Not currently be under audit by the IRS, the Department of Labor, or a state agency concerning the classification of these workers.

Here are the results for employers accepted into the program:

• They will pay 10 percent of the amount of employment taxes that would otherwise have been due on compensation paid for the most recent tax year to the workers, calculated under the reduced rates of section 3509 of the Internal Revenue Code.
• No interest or penalties will be due.
• The employers will not be audited on payroll taxes related to these workers for prior years.
• Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.

Is this an “all or nothing” offer?

Not at all – the program permits taxpayers to reclassify some, or all, of their workers. However, once a taxpayer chooses to reclassify certain of workers as employees, all individuals in the same class must be treated as employees for employment tax purposes.

For example, a construction firm currently contracts with drywall installers, electricians and plumbers to perform services at housing construction sites. The company wants to voluntarily reclassify its drywall installers as employees. Once a closing agreement is executed with the IRS, the company must treat all drywall installers as employees for employment tax purposes.

As with all tax moves, be sure to contact us before you contact anyone else.