INDEPENDENT CONTRACTOR AMNESTY PROGRAM
By: Jenifer M. Pinkham, Esq.
We know as you meet with your clients for tax season, they may ask you similar questions to those that were posed to us recently. At the end of 2012, a half-dozen employers contacted us asking whether they should reclassify their independent contractors as employees at the start of the new year. In several cases, the conversation was started because questions were raised by their CPA’s regarding whether or not the workers were misclassified. Each misclassification situation must be addressed on a case-by-case basis but several clients had questions relative to the Internal Revenue Service (“IRS”) Amnesty Program.
The IRS recently announced an expansion of its Independent Contractor (“IC”) Amnesty program also known as the Voluntary Classification Settlement Program (“VCSP”) which it first started in September of 2011. Through this program the IRS permits taxpayers to voluntarily reclassify ICs as employees for federal employment tax purposes. Employers in the program generally pay just over 1% of the wages paid to the reclassified workers for the past year. There are no penalties and no interest, and employers will not be audited on payroll taxes related to these workers for prior years.
The expansion of the VCSP allows more employers to take advantage of the program, even those under IRS audit, those who failed to issue 1099’s previously and also changes the statute of limitations or look back period. Employers under IRS audit now qualify as long as the audit is not specifically over employment taxes. Previously under the VCSP employers were barred if they failed to file Forms 1099 for the workers they want to reclassify. However, until June 30, 2013, the IRS is waiving this requirement. Employers applying for the temporary relief for those who failed to file Forms 1099 pay a slightly higher amount than other participants plus some penalties. In addition, they must file any delinquent Forms 1099 for the workers they are seeking to reclassify. In addition, the IRS has reduced the special six-year statute of limitations to a normal three year statute.
To be eligible for the VCSP, an employer must:
- Currently be treating the workers as independent contractors;
- Consistently have treated them as such in the past, including filing Forms 1099;
- Not currently be under IRS audit on payroll tax issues;
- Not be under audit by the Department of Labor or state agencies for the classification of these workers; and
- Not be contesting the classification of the workers in court.
Beware of this program for the following reasons: first, it does not provide any form of reduced penalties or interest with respect to the array of other federal and state laws that are implicated by reclassification, including state tax, unemployment, and workers’ compensation as well as the federal wage and hour laws; and second, although the program evidently contains a provision that there is no admission that the taxpayer misclassified its workers as ICs, the likely presumption by the workers themselves, their lawyers (if any), and other federal and state agencies that may become involved is that the company would not have entered the program if it had been classifying its ICs correctly.
Massachusetts has one of the most employee-friendly independent contractor laws in the country. The Massachusetts law creates a heavy presumption of employee status and makes it very difficult to establish independent contractor status. Many Massachusetts employers have struggled with its application, a task made more difficult by the state’s aggressive enforcement. Recently, the Massachusetts Joint Enforcement Task Force on the Underground Economy and Employee Misclassification announced “the commissioning of a research study to show the current depth and scope of employee misclassification and the underground economy in Massachusetts.” The study is expected to be completed in 2013 and may be result in more onerous enforcement.
In 2008, Massachusetts Governor Deval Patrick signed Executive Order #499 establishing the Task Force to address employer fraud and worker misclassification. The Task Force’s “guiding principles” were and are agency cooperation, the sharing of information, and the efficient use of resources to target violations and to educate the public. Massachusetts has sent a clear message: it is prepared to eradicate the misclassification of employees as independent contractors in the state. The increased communication and cooperation among the state agency “stakeholders” in rooting out misclassification likely will increase audits and enforcement action focused on independent contractors.
Employees misclassified as ICs under current laws can be costly for businesses, regardless of whether the employees have been mistakenly or intentionally misclassified. For some businesses, particularly those highly reliant on ICs, the potential costs of misclassification can be extremely high. Risks include liability for unpaid federal, state and local income tax withholdings and Social Security and Medicare contributions, unpaid workers’ compensation and unemployment insurance premiums, and even unpaid work-related expenses and overtime compensation. Any one of these types of liabilities (plus interest and penalties for non-compliance) can be potentially devastating for businesses that make substantial use of ICs.
We recommend that Massachusetts employers should consider taking steps to evaluate, identify and correct any misclassification issues. For reasons discussed above, businesses interested in reclassification that they should consider doing so voluntarily without entering the VCSP. Implementation also requires businesses to consider whether voluntary reclassification requires a different manner of compliance with relevant federal and state tax, employee benefits, and labor laws. If you have any questions about whether a worker is misclassified or how to voluntarily re-classify your workers, please do not hesitate to contact Jenifer M. Pinkham at 781-848-5028 or firstname.lastname@example.org.