The IRS’s New Employee Reclassification Program Is Not What It Claims

Many companies hire independent contractors for limited projects to reduce overall costs. Companies do not withhold income, Social Security or Medicare taxes for independent contractors and do not provide the same benefits generally offered to regular employees. It becomes the contractors’ responsibility to pay their own self-employment taxes and benefits.

Independent contractors usually only pay those taxes at the end of the year, whereas companies deposit employee tax withholdings with the government on a regular and frequent basis. Thus, the government prefers workers classified as employees rather than independent contractors. When employees are misclassified as independent contractors, the IRS claims it can collect back taxes and impose penalties.

A recent Government Accountability Office (GAO) report estimates the Internal Revenue Service (IRS) is losing billions of dollars on employee misclassifications. To remedy that, the IRS recently launched the Voluntary Classification Settlement Program (VCSP) to relax the threat of penalties and reduce the tax impact of employee misclassification.

By reclassifying independent contractors as employees through the VCSP, the IRS says employers can reduce their tax liability from the previous year for those workers to a flat 10 percent. However, Forbes contributor Stephen J. Dunn asserts that the IRS has no legal basis for retroactive tax assessments for mistaken misclassifications. Moreover, participating in the VCSP requires an agreement to allow a longer period for employment tax assessment for the next three years.

Businesses should be cautious of unnecessarily reclassifying workers if there is a reasonable basis for an independent contractor classification. The costs of processing tax withholdings and providing employee benefits can make reclassification expensive. The VCSP may be a means of scaring businesses into sending the IRS tax withholdings instead of making the IRS collect from independent contractors. Businesses concerned about VCSP participation and their employee classifications should contact an attorney knowledgeable in tax matters to learn more.