New IRS Program Will Reduce Misclassification Paperwork

Until a new Internal Revenue Service (IRS) voluntary worker classification settlement program went into effect many employers have avoided reclassification because of the impact.  The new program will greatly reduce the amount of red tape employers must cut through when reclassifying workers.

Up until last month, if an employer wanted to voluntarily change the classification of its workers from independent contractors to employees, the employer would have to amend tax forms for each quarter for the three previous years, meaning it would have to file up to 12 941-X forms to obtain Section 530 relief. It was quite an involved process.

Under the new voluntary classification settlement program, businesses could be reclassified for federal employment tax purposes without any sunset of the program announced.  To be eligible for the program, a business must:

  • Have consistently treated the workers as nonemployees.
  • Have filed all required Forms 1099 for the workers for the previous three years.
  • Not be under an IRS, Department of Labor (DOL) or state government agency audit concerning the classification of the workers.
  • Be in compliance with the results of any previous IRS or DOL classification audit.

The impact on the business is that:

  • The taxpayer agrees to prospectively treat the class of workers as employees for future tax periods.
  • The taxpayer will pay 10 percent of the liability amount based on the compensation paid to the workers for the most recent tax year.
  • No Federal Unemployment Tax Act tax will be due.
  • No penalties and no interest will be imposed.
  • The IRS cannot audit the classification of the workers for prior years.
  • The taxpayer agrees to extend the statute of limitations on the assessment of employment taxes for three years for the first, second and third calendar years beginning after the date the taxpayer agrees to treat workers as employees.

There will be likely be an impact on benefit plans.  If a qualified retirement plan says it benefits all employees and workers have been excluded as nonemployees, the reclassification to employees will make them benefit eligible automatically unless the plan is amended.

It is important to consider the impact on insured health plans because the company must provide similar coverage to 70 percent of all employees or a reasonable classification of employees that does not discriminate in favor of highly compensated employees.  The failure to provide nondiscriminatory coverage is subject to a $100 per day penalty per employee. The IRS is not enforcing the penalty, which was newly added by the Patient Protection and Affordable Care Act, until guidance is issued.

For self-insured health plans, the failure to provide nondiscriminatory health plan coverage makes the medical benefits provided to highly compensated employees taxable unless the entire premium is included in highly compensated individuals’ taxable income.

Are you confident that your Independent Contractors are classified correctly? If you have questions, please contact Sandie Peterson, SPHR at (239) 433-5554.

Based on article by Allen Smith, J.D., SHRM’s Manager of Workplace Law Content, October 20, 2011.