For several years the Internal Revenue Service (IRS) has been taking steps to improve compliance with worker classification requirements. Taxpayers that treat employees as independent contractors may be liable for employment taxes for improperly reported payments. While there is much guidance on determining whether a worker should be treated as an employee or independent contractor, in many cases there is not a definitive answer or the situation is misinterpreted. There are instances where workers who are employees are treated as independent contractors, exposing the taxpayer to potentially significant taxes, penalties, and interest.

The IRS has developed a new program, Voluntary Classification Settlement Program (VCSP), which allows taxpayers who are currently treating certain workers or a class of workers as independent contractors to prospectively treat them as employees. The program allows the reclassification with partial relief from federal employment taxes for the past non-employee treatment.

Under the VCSP, an employer can treat the reclassified workers as employees for future tax periods. The employer must pay 10% of a reduced rate of employment tax for compensation paid to those workers during the most recent year. For 2011, the applicable reduced rates are 10.28% of wages up to the social security wage base and 3.24% of excess wages. Interest and penalties are not assessed under the program. In addition, the employer will not be subject to audit adjustments to employment taxes for prior years with respect to the reclassified workers.

In order to participate in the VCSP, eligible taxpayers must file Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before the date they want the workers to be treated as employees. Eligible taxpayers are those who have treated the workers as independent contractors and filed the required Forms 1099 for the past three years. Taxpayers currently under audit by the IRS are not eligible. Taxpayers accepted into the VCSP must enter into a closing agreement with the IRS and pay the calculated tax due.

If you have workers or a class of worker that you are currently treating as independent contractors and are not totally confident of this classification, you may want to review the relationship and consider the VCSP, if applicable.