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The costs associated with employee misclassification can be brutal -- up to half of a misclassified employee's salary for each year of the misclassification, when unpaid federal and state taxes are involved, along with penalties and interest. This is why the IRS is working with employers to voluntarily reclassify employees and still limit the damage. Employers who may need this relief but find they have missed the June 30 deadline may be eligible for other mechanisms which also provide some measure of relief, if the IRS determines they have misclassified workers. Now is a good time to sort it out because the IRS and Department of Labor will be paying closer attention to the issue given the prospect of de facto employees missing out on mandated health coverage under the Affordable Care Act come January 1. If you had been considering arbitrarily shifting some employees to independent contractor status, forget about it. "A worker cannot just walk out of work on a Friday as an employee and return on Monday as an independent contractor… there has to be some change in the relationship, such as a change in the employer's business or the worker opened his/her own business," warns Preston Burch, an attorney with the firm of Ogletree Deakins. Even if you have paid close attention to the classification standards and followed them, you'll still face the music if the IRS disagrees with your interpretation of those standards. According to Vicki M. Nielsen, also an attorney with Ogletree Deakins, a degree of subjectivity is generally involved in such judgments. Following are highlights of some of the ways employers may be able to stay out of trouble, or minimize the damage. Section 530 Safe Harbor This is a virtual free pass, even if the IRS believes you have misclassified some workers. Not all employers will qualify, however. You must have filed 1099s for the independent contractors, classified workers employees with similar jobs consistently, and have a "reasonable basis" for treating the particular workers as independent contractors. You can read the IRS explanation of "reasonable basis" in the sidebar. According to Nielsen, Section 530 does not grant relief to "certain services" provided by technical workers, including engineers, designers, drafters, computer programmers "or similar workers in a similar line of work" if the IRS deems them to be employees. Also, even if you fall within the Section 530 Safe Harbor, workers who would ordinarily be deemed employees but are not, can still leave you exposed to paying excise taxes under Section 4980(a) of the Affordable Care Act if those workers don't have access to your health plan and seek coverage through a health care exchange. Section 3509 Relief This provision reduces your liability for worker misclassification to 1.5 percent of employee wages subject to federal income taxation, and 20 percent of FICA taxes that should have been withheld. But to be eligible for this relief, you must have issued 1099s both for wage and FICA tax purposes. Also, if the IRS concludes you intentionally disregarded deduction and withholding requirements, you are ineligible for relief under this provision. Classification Settlement Program Two levels of relief are available under this program, applicable to employers undergoing a federal employment audit. It requires you to reclassify workers as employees going forward. Greater relief is available if you have properly filed 1099s and have a plausible basis (although rejected by the IRS) for falling within the Section 530 safe harbor. Specifically, your liability is only "25 percent of the employment tax liability … for the most recent year under audit" based on rates under Section 3509, according to Nielsen. But if you lack a plausible claim to Section 530 relief, you'll be subject to the full tax bill based on Section 3509 rates, she adds. IRS Voluntary Classification Settlement Program This is available if you wish to reclassify independent contractors as employees, step forward and work with the IRS when you are not already undergoing an audit by federal or state authorities. You must also have filed 1099s for the past three years for affected workers. This requirement is waived, however, for the temporary VCSP which expires at the end of June. If you qualify, you are granted immunity for the past, and your obligation is to pay 10 percent of reclassified workers' federal employment tax for one year. The percentage is actually higher -- 25 percent -- under the temporary program, presumably in exchange for the dropped prior 1099 filing requirement. Nielsen urges caution about taking advantage of the VCSP because it only pertains to federal employment taxes. Laying out all your cards "may expose employers to a host of other worker and state consequences," she warns. If you are not certain your company has properly classified all workers, the sooner you deal with the problem the better. However, it's always wise, before jumping into a program such as this to consult with your trusted tax advisers. They should be able to steer you through the rough waters of compliance while minimizing the turbulence. At HR&P we know what drives your company. We have built a reputation on providing exceptional customer service and administrative solutions that help companies improve productivity and profitability. Please give us a call at 281.880.6525 or visit us HERE and we will be happy to talk to you. About HR&P:
Since opening our doors in 2000, HR&P has offered the highest quality human resource outsourcing and payroll services to a diverse pool of clients. By processing your payroll, managing your benefits and overseeing your human resource issues, HR&P makes your workforce flexible and able to meet your changing business demands. Our ongoing goal is to continue to develop specific solutions for each client that suit their particular needs. Contact HR&P:
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