October 13, 2011

Should You Re-Classify Your Employees?

Employment classification has created much angst between government agencies, both federal and state, and employers.  At the heart of this conflict is whether an individual should be classified as an independent contractor, or as an employee.  Contrary to popular belief, an employer does not necessarily have the discretion to classify employees as independent contractors, or as common law employees; rather, it is determined by the facts and circumstances of the work relationship.  

The IRS has just offered a Voluntary Classification Settlement Program (VCS Program) to allow employers to re-classify individuals from independent contractor to employee status, and avoid significant tax liability, including interest and penalties.  

To qualify for the VCS Program, the employer must:

  1. Have historically classified the affected group as independent contractors; 
  2. Filed the appropriate Form 1099s for the three prior years; and
  3. Not currently be under audit by the IRS, the DOL, or any state agency. 

If the employer determines that the group of individuals should actually be classified as employees, the employer can file a Form 8952, and enter into a closing agreement to re-classify, on a prospective basis, a group of individuals as common law employees. 

As part of this settlement, the employer would pay 10% of employment tax liability for the most recently closed tax year.  This amount could be significantly less than what the employer might owe if audited. 

In determining whether the VCS Program is right for you, remember that in addition to the IRS and Treasury Department’s interest in proper classification of employees, the Department of Labor and certain state entities also have a vested interest in independent contractor vs. employee status.  The VCS Program is not binding on these organizations. 

Further, several weeks ago, the IRS and Department of Labor entered into a memorandum of understanding, together with several state agencies, to share information relating to employee status, all of this in an effort to ensure that individuals are properly classified. 

The bottom line is, employers should make certain that their workforce is properly classified, and if an employer has any questions about compliance with federal and state employment status laws, it should consult with its legal and tax advisors.

IRS Resource Information:


The information contained in this Benefit Beat is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations.

As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this Benefit Beat is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

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