The IRS recently announced their voluntary “worker reclassification” program (the “VCSP”) which incentivizes employers by (1) lowering current year employment taxes, (2) waiving of interest and penalties and (3) avoiding of prior year employment tax audit exposure. The VCSP encourages employers’ reclassification of workers as employees who were previously treated as independent contractors.

But, is it a gift or a Trojan horse?

Background:

The magnitude of employment taxes on “common law employees” spawned serious tension over service provider classifications (i.e. employee versus independent contractor). Many businesses err, and continue to err, on the side of independent contractor classification hoping to avoid a plethora of administrative and benefit costs and tax burdens.

Historically, employees for IRS purposes are “common law employees” which is a “legal term of art” not defined in the Internal Revenue Code (the “Code”).

As one of the Code’s “all the facts and circumstances” tests, these worker classification determinations are frequently problematic. Factors such as control over the details and means of work, furnishing tools, providing a place to work can impact classification. However, “facts and circumstances tests” like this one are notorious for creating as much confusion as they avoid.

This uncertainty, the proliferation of IRS employee classification positions and creative taxpayer litigation positions reached such a pitch in 1978 that Congress enacted a “safe harbor” provision which forced some level of certainty back into this theater.

Section 530 Safe Harbor:

In 1978, as part of the Revenue Act of 1978 (but interestingly, not as part of the Internal Revenue Code), Congress enacted a “temporary safe harbor relief statute” (aka “Section 530”). Section 530’s avowed purpose was prevention of the IRS’ retroactively reclassifying workers from independent contractors to employees; provided that, the employer satisfies certain criteria.

Section 530 doesn’t refine the classification process but merely relieves qualifying employers of employment tax liabilities even in cases where their workers are employees. It also relieves employers from the statutory/ common law rules necessary to avoid reclassifying workers from independent contractors to employees.

Hence, in recent years IRS worker classification/reclassification inquiries have focused on Section 530’s three (3) qualifying tests; namely, (1) reasonable basis test, (2) tax return test and (3) position test. Compliance with each test is the employer’s burden. Interpreting these three (3) necessary tests is both complex and beyond the scope of this piece.

If you’re wondering if your business can avail itself of the Section 530 Safe Harbor, please contact your H&M tax advisor.

Voluntary Classification Settlement Program:

The VCSP permits qualifying employers’ reclassification of their independent contractors to employee with the following advertised incentives:

• Pay only 10% of the employment tax liability for “wages” paid to workers during the most recent tax year,
• Pay no interest or penalties on that liability, and
• Not being subject to an employment tax audit worker classification audit for prior tax years.

Not all is sunshine and roses—you must extend the statute of limitations (the “SOL”) by three (3) years for each of the three (3) tax years following the year of VCSP participation which represents a dramatic lengthening of the SOL.

VCSP qualification is not a forgone conclusion. Qualification demands: (1) consistent treatment of workers as independent contractors and (2) filing all required 1099 forms for the “workers” for the previous three (3) tax years. The latter point may be a stumbling block for employers.

However, even if you met the “qualifications” qualification isn’t assured. A quote from the IRS notice announcing the VCSP states….”The IRS retains discretion whether to accept a taxpayer’s application and verified eligibility.” The soldiers are exiting the Trojan horse as we speak!

Should you pursue the VCSP?

One the one hand, if your workers are clearly employees under recognized classifications tests or if you can’t qualify for Section 530’s safe harbor and you can qualify for this Program, VCSP participation limits your prior tax exposure and provides some certainty in terms of your future employment tax exposure.

On the other hand, if your workers are clearly independent contractors under recognized classification tests, or if you qualify (and can defend such qualification) for Section 530’s safe harbor, participation not only exposes you to tax and it most likely eliminates your ability to rely on Section 530 in future.

Surely some business owners suffer from anxiety over their current/past employment tax return worker classification positions, but this apparent “amnesty” program holds attractiveness mostly for those whose audit lottery number hasn’t been drawn. If your classification is sound or Section 530 provides an effective safe harbor, your response might best be “thanks but no thanks.”

Worker classification and Section 530 qualifications might fairly be characterized as technical. Correspondingly, if VCSP seems attractive, contact your H&M tax advisor so you can make this important decision armed with the necessary information.