An ongoing issue with the IRS is the misclassification of employees as independent contractors. For the employee, it creates a burden of additional taxes on earnings, along with having to file a Schedule C with the 1040 at the end of the year. For the employer, a short-term benefit is reaped as the employer avoids payroll taxes and other costs associated with having employees. But this is not always the legal approach to take. The IRS is vigilant about seeking out misclassified workers.

The IRS has certain guidelines that specify when a person should be classified as an employee as opposed to an independent contractor. Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be completed to help make a proper determination. The form can be sent to the IRS for a determination by them, or it can be used internally to make youer own determination. The bottom line on the distinction between the two is the matter of control, particularly behavioral and financial control. If you, as the employer, exercise control over the employee and the manner in which the job is undertaken, you probably have an employee who should receive a W-2.

A determination by the IRS that an employer has been misclassifying employees as independent contractors can be very expensive, as the employer may be required to pay the back taxes plus penalties and interest. In addition, a ruling against the employer may also expose him or her to unemployment taxes on the state and federal level.

In an effort to get employers on the right track without exposure to this significant liability the IRS implemented the Voluntary Classification Settlement Program (VCSP). This program VCSP provides partial relief from federal employment tax penalties for eligible taxpayers that agree to treat workers as employees in the future. Under the Program, eligible employers can obtain substantial relief from prior period federal payroll taxes and related penalties if they reclassify workers as employees for federal employment tax purposes. This is an optional program but one that can reap very large benefits for the employer.

To participate, an employer must 1) Meet certain eligibility requirements, 2) Apply to participate in the VCSP, and 3) Enter into a closing agreement with the IRS. To participate in the program, employers must complete an application on Form 8952 and meet the following qualifications:

1.They have consistently treated workers in the past as nonemployees.

2.They have filed all required Forms 1099 for the workers for the previous three years.

3.Employers cannot be currently contesting in court the classification of the class or classes of workers from a previous audit by the IRS or the Department of Labor.

4.The employer cannot be currently under an employment tax audit by the IRS, the Department of Labor, or a state agency.

If an employer submits an application that is accepted, and agrees to properly classify employees in the future, the taxpayer pays 10 percent of the employment tax liability that would have been due on compensation paid to the workers being reclassified for the most recent tax year.  The employer will not be liable for any interest and penalties on these taxes and will not be subject to an employment tax audit with respect to the worker classification of the class or classes of workers for prior years.

In other words, pay 10 percent of the tax for one year, and liability for that year and all past years are eliminated. This program has been in effect since 2012 and it is not clear how long the IRS will continue the VCSP. Given the very generous terms, an employer should consider participating in the program if workers you qualify for the program. You are eliminating doubt about the past liability and saving a considerable sum of money in taxes, interest, and penalties. You should note, however, that this applies to federal taxes only, and the employer may still be liable for state unemployment taxes.