2011 Voluntary Classification Settlement Program: Are you giving up too much?On Sept. 21, 2011, the IRS announced a new Voluntary Classification Settlement Program (VCSP) for employers to voluntarily reclassify workers (or a class or group of workers) as employees for federal employment tax purposes. The VCSP allows employers to reclassify the workers as employees for future tax periods by paying 10 percent of the taxes that would normally be due if the workers were treated as employees during the last full tax year. The VCSP also limits the employer's exposure to IRS adjustments (due to misclassification) for prior years. If you think this program sounds too good to be true, you may be right. The program is aimed at employers that are eligible for relief from reclassification by the IRS under section 530 of the Revenue Act of 1978.1 Before jumping on the VCSP band wagon, an employer should consider whether it is entitled to relief under section 530 (and thus, doesn't need the protection of the VCSP) and whether the program offers tangible benefits to the employer and the company, benefits which may make the decision to give up section 530 worthwhile. Section 530 is a safe harbor provision enacted in 1978 to protect employers from aggressive IRS activity in the area of worker classification. Although section 530 was intended to be a temporary measure (going hand-in-hand with a moratorium on IRS rulings characterizing workers as employees), it was made permanent by the Tax Equity and Fiscal Responsibility Act of 1982. Section 530 relieves the employer from paying employment taxes and withholding employment taxes and federal income tax from compensation paid to workers classified as non-employees. This relief applies to years under examination and future years, so long as the section 530 requirements are met. To qualify for relief from reclassification of workers, an employer must meet three requirements:
Although these requirements seem somewhat simplistic in theory, each can be time-intensive to support or to examine. Even though the IRS may have staked out its position on a particular requirement, the courts may reject that position.2 Further, the reasonable basis standard is not a bright line standard and, thus, the IRS may not always agree with the taxpayer's analysis and conclusion. Similarly, the industry standard requirement can be difficult to apply because there may not be a standard for the industry or a significant segment.3 The VCSP offers an alternative to provide certainty to a determination on the classification of workers. Certainty may allow for the release of financial statement and tax reserves. The coverage of the workers under employee benefit plans may also improve worker morale and longevity with the company. However, before a company decides to enroll in the VCSP, it should thoroughly evaluate its workers' status under the requirements for section 530. If section 530 would offer protection, the company should weigh the risks and alternatives before enrolling. Taxpayers eligible for the new VCSP must meet certain criteria:
The eligibility criteria for the VCSP cover two of the three requirements for section 530 relief. If a taxpayer can show reasonable basis for classifying its workers as non-employees, it should consider whether the program offers any tangible benefit that is not outweighed by the cost. This is an important consideration. The VCSP is a voluntary program and is available to eligible taxpayers that apply for it. Resolution of the worker classification issues are documented in a closing agreement. Taxpayers participating in the program must agree to extend the period of limitations on assessment of employment taxes for three years after the year covered by the program. This statute extension allows the IRS to review the taxpayer's compliance with the terms of the closing agreement. Insights:Companies with non-employee workers have been on the IRS's radar screen for many years and, today, we are experiencing increased employment tax examinations. Still, the use of non-employee workers may be proper and consistent with industry practice for the type of work performed, and in the taxpayer's industry. Prior to enrolling in the VCSP, employers should evaluate whether they have a reasonable basis for their treatment of certain stratifications of workers as non-employees. If the classification of the workers as non-employees is based on judicial or administrative authorities, industry practice of a significant segment of the employer's industry, or if the IRS examined the employer prior to 1996 and did not raise (or even look at) the worker classification issue, the employer may have a reasonable basis to treat the workers as non-employees and, if the other criteria are met, it may qualify for the section 530 safe harbor. If the safe harbor applies, employers should consider whether there are non-tax reasons to change the classification of its non-employee workers before giving up that safe harbor and enrolling in the VCSP. Patti Burquest, Managing Director, Tax Controversy Services, Washington National Tax Bob Adams, Managing Director, IRS Practice and Procedure, Washington National Tax 1See section 530 of Public Law 96-600, 92 Stat. 2885 (1978) as amended by Public Law 96-167, 93 Stat. 1278 (1979), Public Law 96-541, 95 Stat. 3204 (1980); Public Law 97-248, 96 Stat. 552 (1982); and Public Law 104-188, 110 Stat. 1766 (1996). |