For over two years we have been warning clients and readers about the Federal government’s increasing enforcement of the employment tax and labor laws. The primary focus is on catching employers who classify full-time employees as “independent contractors.” When caught, such employers can be held liable for retroactive benefits, employment taxes and penalties.

A new IRS effort, named its Voluntary Classification Settlement Program (VCSP), seeks to induce employers to voluntarily take employees out of the “independent contractor” category. Announced in October, 2011. VCSP is IRS’ attempt to add incentives to its existing enforcement efforts, to create a “carrot and stick” approach. But employers tempted to obtain VCSP’s benefits should carefully consider the risks of jumping onto VCSP’s bandwagon. VCSP Benefits

The primary benefit which VCSP offers to eligible employers is substantially an amnesty for past violations if the employers agree to reclassify so-called independent contractors as employees, and to treat them as employees. IRS has provided similar relief to employers already targeted in “misclassification” enforcement proceedings but now seeks to induce employers to turn themselves in to IRS without the employer being the target of any existing proceeding or investigation.

A company joining VCSP agrees to treat some or all of workforce as employees for future tax periods. The company, if found to be eligible, is relieved of 90% of its employment tax liability for the most recent tax year and is not charged interest or penalties on what its full liability could have been, In addition, IRS waives employment tax audits for the reclassified workers for any prior years. VCSP Pitfalls

While joining VCSP will generally resolve a company’s prior misclassification tax problems on the Federal level, after turning itself in to the IRS the company may still be exposed to investigations and actions by the U.S. Department of Labor, other U.S. agencies and state tax and other enforcement efforts.

Further, not every company is eligible for VCSP benefits. The criteria for eligibility are spelled out by IRS and the company’s legal counsel should be asked to review the applicable rules and the company’s record of compliance, before the company submits its VCSP application to IRS. IRS can also deny the application in its discretion. Thus, turning itself in could be the worst possible move for a company.

Two more downsides of VCSP are that it doubles the employment tax assessment statute of limitations for the first three years of operations under VCSP, and binds the employer to treat the newly classified employees as such for all future tax periods.

Participation in VCSP and a reclassification of workers as employees can also open up a host of labor law, wage and hour law, discrimination law, ERISA and other issues and claims by reclassified employees. A company’s increase in the number of its employees (as the result of reclassification) may also render it subject to additional regulation or other legal requirements.

Employers facing potential worker misclassification problems must carefully assess their potential vulnerability to these threats before contacting the IRS or making an application under VCSP. The program may, in fact, be very beneficial for some companies and should not be shunned. On the other hand, a poorly-considered VCSP application may result in a company’s jump from the frying pan into the fire.

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