Payroll Tax Settlement for Misclassified Workers
Payroll taxes consist of two kinds of taxes: withholding tax taken from employees’ wages and a tax paid from the employer’s own funds. Taxes vary depending upon the type of worker. Generally, an employee and an independent contractor are determined by whether or not the service recipient has the right to control how the worker performs the service. Because this is such a broad definition, many businesses misclassify their employees as 1099 independent contractors either unintentionally or in order to avoid paying employee benefits or higher payroll taxes. If caught by the IRS, your business can face major penalties, specifically under the Trust Fund Recovery Penalty Act. Under this act, any money that was collected and should have been turned over to the government must be paid. The IRS has provided two different channels to avoid incurring serious penalties.
Voluntary Classification Settlement Program
The IRS has developed a Voluntary Classification Settlement Program (VCSP) to encourage businesses that had misclassified employees as workers to correct this with minimal repercussions. The employer must reclassify all workers of the same class as employees for future tax periods. In doing so, the IRS grants full employment tax audit relief for previous years and only requires a payment of 10% of the liability due to cover past payroll tax obligation. This payment would be without interest and there would be no extra penalty due. In addition, the taxpayer would agree to extend the period of limitations on assessment of employment taxes to six years instead of the usual three.
In order to be eligible to file for the VCSP, a company must meet certain requirements. A company must have been consistently treating the workers as independent contractors and non-employees. This includes having filed any required forms 1099 for the past 3 years. Additionally, the employer cannot currently be under audit by the IRS or any other state agency in regards to classification of workers.
Section 530 of the Revenue Act of 1978
Despite the many benefits of the VCSP, there is another option that may be more advantageous. Under Section 530 of the Revenue Act of 1978, businesses are also able to reclassify their workers. If all requirements are satisfied, a company can reclassify its workers without having to pay any liability, interest, or penalty.
There is one more eligibility requirement for section 530 than for the VCSP program. Aside from having filed the appropriate 1099s and having consistently treated the workers as independent contractors, a company must also be able to provide a “reasonable basis” for previously classifying employees as 1099 independent contractors. An example of an adequate reason would be that the misclassification is a widespread industry practice. Other examples include relying on an attorney’s or CPA’s opinion, a previous IRS audit, or case law.
Comparing Section 530 to the VCSP
The IRS guides employers to the VCSP so that employers looking to reclassify their workers must pay some liabilities. Yet many employers do not look into Section 530, which would allow them to achieve the same without paying. Conversely, one of the advantages of the VCSP is that it requires only three years of 1099 forms to have been filed, whereas Section 530 requires any 1099s that have been filed from 1970 onward. Since many companies have not been in business since 1970, this typically encompasses all Form 1099s filed in the company’s lifetime. Although there is one more eligibility requirement for Section 530 than for the VCSP, the requirement is often easy to show. Since the decision is different on a case-by-case basis, business taxpayers should decide upon the appropriate course of action after weighing in various factors and seeking the advice of tax counsel.
For more information or assistance in determining eligibility to file under Section 530 or the Voluntary Classification Settlement Program, contact Larry Horwitz at firstname.lastname@example.org.