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Jean   Murray

Should You Reclassify Contract Workers as Employees? What You Need to Know

By January 7, 2013

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The IRS wants to make sure your workers are classified correctly. In other words, if your workers are really employees, but you are paying them like independent contractors, the IRS you to pay them as employees instead. You should know that the IRS assumes that a worker is an employee unless there is substantial reason to believe the person is an independent contractor. Every case is different, but you can read more about the difference between an employee and an independent contractor.

So what's the big deal, you ask? Well, it's about - yes, you guessed it - taxes. In this case, it's payroll taxes (Social Security/Medicare) and income tax withholding. If you pay employees, you have to withhold those income taxes and payroll taxes; if you pay a contract worker who is not an employee, you don't have to withhold those taxes. But if the taxes aren't withheld, there's a better chance that they won't get paid...to the IRS.

To encourage businesses to classify workers correctly, the IRS has come up with a program, started in 2011, called the Voluntary Classification Settlement Program (VCSP). Briefly, the program provides "relief" (in the form of lower payments for unpaid taxes) for companies who meet certain criteria and who voluntarily re-classify workers as employees.  The IRS says:

The VCSP is optional and provides taxpayers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past nonemployee treatment. To participate, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP, and enter into a closing agreement with the IRS.

A recent (December 17, 2012) announcement modifies the program by allowing companies under IRS audit (other then an employment tax audit) to participate, clarifing eligibility to participate, and eliminating the requirement that the company agree to certain stipulations. (It's complicated, and if you have questions you'll need to read the December 17, 2012, announcement.)

How to Sign up: If you decide you have workers who are contractors but who should be employees, you may want your company to participate in the VCSP.

1. First, contact your employment attorney and review your specific situation. Then, if you both decide participation is a good idea,

2. Complete and submit Form 8952, Application for the VCSP.

Read the original IRS announcement about the Voluntary Classification Settlement Program, and some FAQ's about the program.

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