Posted by: Garcia & Cuadra, PA | February 19, 2016

Classification of Workers: Employee Vs. Independent Contractor (Part 2 of 2)

Employee Vs. Independent ContractorThere are avenues of relief when an employer has misclassified workers when doing the hiring and staffing in their business.   Section 530 of the Revenue Act of 1978 provides safe harbors under which a business can take refuge when there is no statutory designation for the worker.  The requirements are:

  1. The employer must not have treated the worker, or any other individual holding a substantially similar position, as an employee for any period, and
  2. The employer filed all required federal tax returns, including information returns (Forms 1099MISC) for the worker for all periods after 1978 on a basis consistent with treating the worker as an independent contractor.

The safe harbor will not apply if the business or its predecessor has treated any other worker holding a substantial similar position as an employee for employment tax purposes for any period beginning after 1997.   A business must also have a reasonable basis for treating an individual as an independent contractor.  Under Section 530, “reasonable basis” exists if any one of the following items exists when characterizing a worker:

  1. Judicial precedent, published IRS rulings, technical advice with respect to the taxpayer, or a private IRS letter ruling to the taxpayer (the judicial precedent safe harbor).
  2. Long-standing, recognized practice of a significant segment of the industry in which the worker was engaged (industry practices safe harbor), or
  3. A past IRS audit of the business in which there was no assessment attributable to the treatment (for employment tax purposes) of the individual holding positions substantially similar to the position held by this individual (the prior audit safe harbor).

Another avenue of relief from paying back payroll taxes and penalties to the taxing authorities is available under the Voluntary Classification Settlement Program.  This is an optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for those who agree to prospectively treat their workers (or a class or group of workers) as employees.  To participate in this new voluntary program, the taxpayer must meet certain eligibility requirement, apply to participate by filing IRS Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.  The eligibility requirements include:

  1. The taxpayer must have consistently treated the workers as independent contractors.
  2. The taxpayer must have filed all required Form 1099MISC for the workers to be reclassified under the VSCP for the previous three years to participate.
  3. The taxpayer cannot currently be under employment tax audit by the IRS, the Department of Labor, or by a state government agency.
  4. The taxpayer participating in the VSCP must agree to prospectively treat the class of workers as employees for future periods.

In exchange for this relief (once all requirements are met to qualify under this program), the taxpayer will:

  • Pay only 10% of the employment tax liability that would have been due on compensation paid for the workers for the most recent tax years had the employer been audited on the subject by the IRS.
  • Not be liable for any interest and penalties on the amount; and
  • Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.
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