You have read horror stories about how the IRS audits business owners and deems their 1099 independent contractors W-2 employees—and then assesses tens (or hundreds) of thousands of dollars in back payroll taxes, interest, and penalties.
Are you one of those horror stories?
Okay, let’s say you are one of them. You know that you are an IRS target because you have workers who really should be employees, but you treat them as independent contractors. And you are afraid that if you change now, the IRS will see that change, audit your prior years, and charge big bucks for your mistake.
What should you do? Keep the workers as independent contractors and hope the IRS doesn’t catch on? Or amend your past returns to show the misclassified workers as employees?
Depending on how many workers you have misclassified, and the number of years involved, that amendment process could be cost prohibitive.
The come-clean program, which should have you paying just pennies on the dollar, is the IRS Voluntary Classification Settlement Program (VCSP) for business owners who want to change their worker classification on a going-forward basis.
Not everybody qualifies for the VCSP. To be eligible to participate in the VCSP, you must meet the following requirements:
1. Reporting consistency. You must have timely filed the previous three years’ federal tax returns for your workers (that is, 1099s) consistent with your treatment of the workers as independent contractors.
2. Not currently under audit. You cannot currently be underemployment tax audit by the IRS, or under worker classification audit by the Department of Labor or by any state government agency.
If you decide to participate in the VCSP, you must agree to treat the class or classes of workers covered by the agreement as employees for future tax periods. In exchange, you will receive the following most-favorable benefits:
• Reduced employment tax liability. You pay only 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year. (Pennies on the dollar for one year—about 3.3 percent of what that likely would have been for the past three years.)
• No interest or penalties. You will not be liable for any interest and penalties. (Okay, knock that 3.3 percent down to something like 0.93 percent.)
• Audit protection for misclassifications in prior years. You will not be subject to an employment tax audit for prior years with respect to the workers covered by the VCSP. (Priceless.)
If you have misclassified workers, there is very little downside to participating in the VCSP—except, of course, that you will have to treat the workers covered by the VCSP agreement as employees on a going-forward basis.