IRS to Employers: Raise Your Hand If You've Misclassified Workers

All individuals performing work for an employer should be classified as employees or independent contractors. Employees are then further classified under the Fair Labor Standards Act as "exempt" or "non-exempt" for purposes of overtime compensation. Proper classification of employees and independent contractors can be difficult, and misclassification can lead to significant financial liability in the form of back taxes and overtime pay. 

In an attempt to address misclassification of independent contractors for tax purposes, the IRS launched the Voluntary Classification Settlement Program (VCSP). The goal of the VCSP is to properly classify workers, while collecting unpaid payroll taxes for employees improperly classified as independent contractors. As the IRS explained, "this new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit." An employer's voluntary participation in the VCSP removes the burden of interest and penalties that would be assessed if the misclassification were discovered as the result of an IRS audit.

Despite the many benefits offered by the VCSP, many employers were reluctant to participate because it was unclear whether the facts surrounding the employer's participation would be shared with other government agencies. Of particular concern is the Department of Labor's Wage and Hour Division, which is responsible for enforcing the Fair Labor Standards Act. Employers' concerns were legitimized by the earlier announcement that the IRS, the Department of Labor, and several states would be joining forces to identify wage and hour violations and impose significant fines on non-compliant employers.

In an attempt to address employer concerns about the VCSP, the IRS has issued an FAQ sheet. The FAQ resolved three key fears for employers:

  • The IRS states that it will not share information about VCSP applicants with the Department of Labor or state agencies;
  • An employer that applies for but is not accepted into the VCSP will not automatically be subject to an IRS audit; and
  • Participation in the VCSP is not an admission of liability or wrongdoing with respect to employee classification issues.

With these concerns alleviated, we'll have to wait to see whether employers forward and work with the IRS to address any concerns they may have about whether they have misclassified independent contractors.

See also these previous posts on misclassification of employees:

3d Cir. Rules on Enforceability of Non-Compete Agreements for Independent Contractors

Pennsylvania Passes Misclassification Law

Will "Misclassification Initiatives" Reduce Employers' Use of Independent Contractors?

Read more Labor and Employment Law insights from Margaret (Molly) DiBianca in the Delaware Employment Law Blog.  Ms. DiBianca is an attorney with Young, Conaway, Stargatt & Taylor, LLP.

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