The IRS has launched a program that will enable many employers to resolve past worker classification issues – at a relatively low tax cost – by voluntarily reclassifying their workers. The Voluntary Classification Settlement Program (VCSP) offers participating employers substantial relief from unpaid federal payroll taxes.

According to the IRS, the VCSP is designed to “increase tax compliance and reduce the burden for employers by providing greater certainty for employers, workers and the government.” Under the program, eligible employers can obtain substantial relief from unpaid federal payroll taxes. The IRS program is available to many businesses, not-for-profit organizations and government entities that erroneously treat workers as non-employees or independent contractors and wish to reclassify them as employees.

Eligibility. To be eligible, an employer must:

• have consistently treated the workers as non-employees,

• have filed all required Forms 1099 for the workers for the previous three years, and

• not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers.

Benefits. Employers that are accepted into the program:

• will pay 10% of the amount of employment taxes that would otherwise have been due on compensation paid for the most recent tax year, calculated under the reduced rates of Section 3509 of the Internal Revenue Code;

• will not be liable for interest or penalties on the unpaid employment taxes;

• will not be audited on payroll taxes related to these workers for prior years; and

• will be subject to a special six-year statute of limitations, for the first three years under the program, rather than the normal three years that generally applies to payroll taxes.

Selective Reclassification. If a business signs up for the IRS program, that does not mean that all of its workers have to be reclassified as employees. The program allows taxpayers to reclassify some, or all, of their workers. However, once a taxpayer chooses to reclassify certain workers as employees, all individuals in the same class must be treated as employees for employment tax purposes.

Example: A general contractor subcontracts with drywall installers, electricians and plumbers. The contractor determines that the drywall installers (but not the other categories of subcontractors) should have been treated as employees. Once a closing agreement is executed with the IRS, the company must treat all drywall installers as employees for employment tax purposes.

How to Apply. To participate in the VCSP, a company must apply using Form 8952, Application for Voluntary Classification Settlement Program. The application should be filed at least 60 days from the date the company wants to begin treating its workers as employees. Companies that want to begin treating one or more classes of workers as employees for the fourth quarter of 2011 should file Form 8952 as soon as possible. The IRS claims that it will make every effort to process Form 8952 with sufficient time to allow for the voluntary reclassification on the requested date.

Caution. Consult with your tax adviser or employment lawyer before you decide to participate in the IRS Voluntary Classification Settlement Program. While the VCSP offers real benefits, it may not make sense in some situations.