Richard J. Reibstein,
Lisa B. Petkun, and
Andrew J. Rudolph
The Internal Revenue Service (IRS) announced earlier this week a new
program to permit taxpayers to voluntarily reclassify independent
contractors as employees for federal employment tax purposes.
The program, called the Voluntary Classification Settlement Program (VCSP),
would allow businesses to voluntarily reclassify workers who currently
receive 1099s from the company by making what is referred to by the IRS
as a "minimal payment covering past payroll tax obligations."
That payment to the IRS would be "10 percent of the employment tax
liability that may have been due on compensation paid to the workers for
the most recent tax year, determined under the reduced rates of section
3509 of the Internal Revenue Code," according to the IRS Announcement published
September 21, 2011 on the IRS Web site. Participation in the VCSP would
also eliminate interest and penalties on the liability and, most
importantly, exempt companies from an employment tax audit for worker
misclassification in prior years.
This IRS voluntary program is another alternative means of achieving
compliance with federal tax laws governing employee misclassification.
Those alternatives have been discussed in prior articles and blog posts
by the authors, and include bona fide restructuring of the relationship
between companies and workers paid on a 1099 basis, the use of an
employee leasing or staffing company, and reclassification outside of
any government program - using IC Diagnostics and other proprietary compliance tools of Pepper Hamilton's Independent Contractor Compliance Practice.
Employers that have misclassified workers in the past may also be
eligible for a safe haven from liability for employment taxes under
Section 530 of the Revenue Act of 1978. To be eligible, a business
(other than one utilizing certain technical service workers) must have
had a reasonable basis for treating workers as independent contractors,
must have consistently treated the workers as independent contractors,
and must not have treated any substantially similar workers as
employees. A bill introduced in Congress last year, the Fair Playing Field Act of 2010,
would have eliminated Section 530 relief prospectively, but no action
was taken on that proposed legislation and the bill has not been
re-introduced by this Congress. While Section 530 remains in effect, the
IRS's new voluntary program may be less attractive than Section 530
relief to those companies that believe they qualify for this safe haven.
While there are advantages to participation in this new voluntary
program, there will likely be some genuine concerns by companies that
this new IRS program may backfire and actually increase, rather than
minimize, potential misclassification liability.
In a September 22, 2011 telephone conversation with the principal
author of the IRS Announcement, we raised one of the most pressing
concerns that companies are likely to face: would the IRS share
information about a company's participation in the program with the U.S.
Department of Labor and state labor and tax commissioners under the
IRS's existing information-sharing agreements with other federal and
state agencies under programs recently published by the IRS and U.S.
We noted that a business may be concerned that any sharing of
information by the IRS with other federal and state agencies about a
company's participation in the IRS's new voluntary program may lead to
an unwanted array of enforcement actions by those other government
agencies. Enforcement actions may include investigations, audits,
administrative proceedings and government-initiated lawsuits for
allegedly past unpaid overtime wages, unemployment taxes, workers
compensation premiums, and state tax liabilities - all of which could
expose a company participating in the VCSP to even greater financial
costs than were saved with the IRS. The principal author of the IRS
Announcement was unable to say definitively whether information about
participants in VCSP would or would not be shared by the IRS with other
federal or state agencies.
Another concern about the new voluntary IRS program is that it does
not provide safety from potential misclassification liability stemming
from private lawsuits under federal and state wage and hour laws and the
federal employee benefits law. (Nor does the safe haven under Section
530, for that matter.) Many companies remain concerned about potential
exposure to private class action lawsuits by workers who may claim that
they have been improperly paid on a 1099 basis and are owed allegedly
unpaid overtime under state or federal law or benefits under a company's
employee benefit plans. Such companies may prefer one of the other
alternatives noted above in order to enhance independent contractor
compliance. Those alternatives reduce or eliminate prospective exposure
to misclassification liability not only in the tax context but also in
the labor and benefits arenas.
Yet another potential objection to the new IRS program is that
companies that reclassify individuals who previously received 1099s may
worry that reclassification is a form of "admission" of past
misclassification, as well as an invitation to those receiving 1099s
from the company to challenge their past classification as independent
contractors. Pepper has advised companies how to properly reclassify
workers in a manner to minimize this concern, but changing a worker's
tax treatment may remain a choice of last resort for many businesses.
We will provide further analysis of the VCSP in the future, including
any information published by the IRS regarding the information-sharing
issue discussed above. Questions about this matter can be addressed to
material in this publication was created as of the date set forth above
and is based on laws, court decisions, administrative rulings and
congressional materials that existed at that time, and should not be
construed as legal advice or legal opinions on specific facts. The
information in this publication is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client
article is republished with permission of Pepper Hamilton LLP. Further
duplication without the permission of Pepper Hamilton LLP is prohibited.
All rights reserved.
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