A Win-Win Program: IRS' Voluntary Compliance
By Lauren Williams on 02/06/2012 @ 09:15 AM
A Win-Win Program: IRS Voluntary Compliance Program Provides a Fresh Start to Employers and their Misclassified Employees
Small businesses need to be honest about those they employ versus those they enter into contracts with as independent contractors, and the IRS’s new program—the Voluntary Classification Settlement Program (VCSP)—is designed to motivate more small business owners to do so. The VCSP allows eligible employers to voluntarily notify the IRS that they have erroneously treated their workers as nonemployees or contractors and obtain substantial relief from federal payroll taxes and penalties they would owe for having done so. Employers accepted into the program get a huge break: they will be required to pay an amount equaling nearly 1% of the wages paid to the reclassified workers for the past year, without interest or penalties.
Why does this matter? The Self-Employment Tax Initiative (SETI) is a small business development strategy that takes advantage of the tax code to help low-income, self-employed individuals formalize and grow their businesses, create jobs and access tax-based asset-building opportunities. The target population for the SETI local partners is self-employed individuals who are operating small businesses. The “self-employed” taxpayer, however, may also be an independent contractor whose income is reported on a 1099 MISC by the entity that entered into a contract with them to provide some good or service. When independent contractors earn income, they are treated as self-employed individuals for tax purposes—as such, they pay 15.3% of their income to satisfy Social Security and Medicare taxes while employees only pay 7.65%.
Each year, our local partners—community-based organizations that provide free tax assistance to low- and moderate-income self-employed taxpayers—tell us stories about the misclassified employees they serve at their tax sites. Most are actually employees dealing with unscrupulous employers who have deliberately classified their employees as independent contractors in order to avoid paying the employer share of payroll taxes. This means that when they file, they are responsible for both the employer and employee share of Social Security and Medicare taxes. These filers, when informed of their “self-employed” status, are often confused and financially unprepared to bear the full load of both employer and employee portions of Social Security and Medicare contributions.
Many of the partners we work with will help misclassified employees by walking them through a series of questions to determine whether they are, in fact, employees or independent contractors. These programs educate misclassified taxpayers about their tax liability going forward and inform them of their options for recourse. Although the IRS has designed a process for misclassified employees to report their employers, that’s often a risk many low- and moderate-income employees cannot take. Misclassified employees—often the most vulnerable employees—get trapped in a catch-22: they can’t bear the burden of paying the tax rate required of independent contractors, but they can’t risk losing their employment by reporting their employers.
This new IRS program, however, could become a win-win for both the unscrupulous employer and the misclassified employee in some cases. While the program is a huge win for business owners who are classifying their employees as independent contractors rather than W-2 employees and are willing to classify them properly, it may be an even bigger win for low- and moderate-income employees who get reclassified, minimize their tax liabilities and keep their jobs.
Want to Come Clean? The program is new, but it’s already accepted over 200 businesses and is ready to accept more. Frequently Asked Questions are answered on the IRS website, and program eligibility is described here. Although this program will help relieve participating small business owners’ potential federal tax liability, the program has only been adopted at the state level in Minnesota; there’s still work to be done in other states to implement similar pilots.
1200 G Street, NW
Comments
Leave a Comment