Gary Bode, CPA: for a free initial phone consult on this voluntary disclosure program, or Form SS-8, please call 399-2705.
Payroll CPAs get nervous when the IRS fires up the old employee vs subcontractor issue. The IRS had great success with it’s two voluntary foreign banking disclosure/amnesty programs. So, now they’ve instituted a voluntary disclosure program for companies paying employees (as defined by the IRS) as subcontractors.
Before discussing the new IRS Voluntary Classification Settlement Program, let’s take a brief look at the underlying issue.
Clients want to pay workers as subcontractors. Why? To save on unemployment taxes, payroll taxes and Workman’s Compensation insurance. Here’s an example using gross “pay” of $1,000. For, let’s say, the first pay period of the year.
Subcontractor: the company pays $1,000. With little administration cost.
Employee:
- Gross Pay - $1,000.00.
- Employer portion of Social Security - $62.00.
- Employer portion of Medicare - $14.50
- State Unemployment: - $12.00 (assuming a 1.2% rate).
- Federal Unemployment (FUTA) - $8.00
- Workman’s Comp - $30 (assuming a 3% net rate).
So the employer pays an additional $126.50 in various extortions if the worker is an employee. Plus the increased administration time. Plus legal implications if payroll isn’t handle properly. Eventually health insurance premiums would factor in here as well.
You don’t have to be a payroll CPA to understand why companies want to classify workers as subcontractors.
You don’t have to be a payroll CPA to understand why the government wants workers classified as employees.
Consequences of Treating an Employee as an Independent Contractor
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. And the IRS can retrograde this back for years. The financial consequences could bankrupt a company.
Who is an Employee? Per the IRS:
The IRS offers the three guidelines below to help classify workers. They also state there is no magic (sic) formula and that classification is on a case by case determination. The classification is so convoluted that the IRS has a form you can submit to let them decide on the classification: Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Voluntary Classification Settlement Program – Carrot and Stick
If you have paid employees as subcontractors, I believe the IRS will eventually catch you. Why? Let’s say a construction company deducts subcontractor expense on their income tax form. The IRS cross correlates and finds no employment tax return. Bingo, we have a red flag winner.
Carrot: you pay 10% of the employment taxes that would have been due for the last year. They’ll forgive prior years. But you have pay the affected workers as employees from now on.
Stick: Multiple years of full employment taxes become due, if they catch you.
To be eligible for this new program, a taxpayer:
- Must have consistently treated the workers as nonemployees.
- Must have filed all required Forms 1099 for the workers for the previous three years.
- Cannot currently be under audit by the IRS.
- Cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.
Talk to your payroll CPA about this new IRS initiative. You may want to document why your subcontractors are, in fact, subcontractors. You may want voluntarily disclose mis-classification when past penalties are low.
If you don’t have a payroll CPA, please consider calling us for a free initial phone consult at (910) 399-2705. Please note our virtual office allows us to serve a broad geographical base. Our local clients seem to enjoy the convenience as well.
Hre’s the IRS blurb cut ans pasted:
Part IV - Items of General Interest
Voluntary Classification Settlement Program
This document provides notice and details regarding a new Internal Revenue Service Voluntary Classification Settlement program that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat workers as employees.
Announcement 2011-64
I. PURPOSE
The Internal Revenue Service (IRS) has developed a new program to permit taxpayers to voluntarily reclassify workers as employees for federal employment tax purposes. The Voluntary Classification Settlement Program (VCSP) allows eligible taxpayers to voluntarily reclassify their workers for federal employment tax purposes and obtain relief similar to that obtained in the current Classification Settlement Program (CSP). The VCSP is optional and provides taxpayers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past nonemployee treatment. To participate in the program, the taxpayer must meet certain eligibility requirements, apply to participate in VCSP, and enter into a closing agreement with the IRS.
