IRS’s Voluntary Classification Settlement Program Ignores the Penalty Free Relief Available to Employers under Section 530 of the Revenue Act of 1978
The (VCSP) provides employers partial relief from past federal employment tax obligations related to workers voluntarily reclassified from independent contractors to employees. In its announcement of the program, the IRS stated that the goal of the VCSP is to increase tax compliance and reduce the burden for employers.
Notably, the burden that is imposed upon those employers participating in the VCSP is far more than what was required by Congress when it enacted Section 530 of the Revenue Act of 1978.
Under the VCSP, in exchange for being alleviated from interest and penalties on the tax liability attributed to the misclassification, employers will pay a penalty equal to 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year. Although participating employers will not be audited for employment tax purposes for prior years with respect to the worker classification of the workers, they will, however, be subject to a six-year statute of limitations for the first three years under the program instead of the three-year payroll tax statute of limitations.
In discussing the background of worker misclassification in its Announcement, the IRS extensively compared relief obtained under the VCSP to that obtained in the current Classification Settlement Program (CSP). As discussed by the IRS, the CSP allows employers and tax examiners to resolve worker classification issues in the administrative process; however, the VCSP allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through administrative correction procedures applicable to employment taxes.
Significantly, however, the VCSP Announcement as well as the VCSP Frequently Asked Questions fail to discuss an integral provision in the background of worker misclassification, Congresss safe harbor rule, section 530 of the Revenue Act of 1978, which entitles certain employers to reclassify workers as employees without being imposed a penalty.
As discussed by Congress:
Section 530 of the Revenue Act of 1997 is a safe harbor for an employer who owes FICA and FUTA taxes resulting from the improper classification of employee as independent contractor. Thus, if a worker employee is misclassified as an independent contractor under the common-law analysis, the employer will nonetheless escape employment tax liability if the conditions of section 530 are met. Section 530 shields a taxpayer who pays workers for services from employment tax liability if the employer has consistently treated the worker as “other-than-employees” unless the employer had no reasonable basis for doing so. Section 530 should be interpreted liberally in favor of the employer.
Present Law and Background Relating to Worker Classification for Federal Tax Purposes. Page 6. JCX-27-07.Joint Committee on Taxation. (May 7, 2007)
Section 530(a) provides in pertinent:
- In general.
– If “
- for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period, and
- in the case of periods after December 31, 1978, all Federal tax returns (including information returns) required to be filed by the taxpayer with respect to such individual for such period are filed on a basis consistent with the taxpayer’s treatment of such individual as not being an employee,
then, for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee.
- judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;
- a past Internal Revenue Service audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual; or
- long-standing recognized practice of a significant segment of the industry in which such individual was engaged.
Similarly, in order to be eligible for the VCSP, employers must meet the following criteria:
- Employer must have consistently treated the workers in the past as nonemployees;
- Employer must have filed all required Forms 1099 for the workers for the previous three years; and
- Employer must not currently be under audit by the IRS, the Department of Labor, or a state agency concerning the classification of these workers.
By failing to address section 530 in its discussions of the VCSP, the IRS is guiding Taxpayers into a voluntary penalty regime they may otherwise not be subject to. Because section 530 was never codified as part of the Internal Revenue Code, most Taxpayers are oblivious of its existence. The IRS is taking advantage of this unawareness by marketing the VCSP as if it is the Taxpayers most favorable outcome. Notably, however, when given a choice under the two schemes, it is inconceivable why Taxpayers would choose to be penalized.
Section 530 relief was recently discussed on November 17, 2011, during the American Bar Associations (ABA) 22nd Annual Philadelphia Tax Conference. According to these discussions, which included Ligeia Donis, Assistant Branch Chief in the IRS Office of Chief Counsel, Tax Exempt and Government Entities and numerous tax practitioners, the benefit of VCSP over section 530 relief is the certainty it provides. According to one practitioner, “although an employer may believe it has an ironclad case for section 530 relief, there is always the possibility the IRS will disagree.”
Remarkably, this discussion of section 530 is contrary to Congresss Joint Committee on Taxation, which expressly stated that “section 530 should be liberally construed in favor of the Employer.” Present Law and Background Relating to Worker Classification for Federal Tax Purposes. Page 6. JCX-27-07.Joint Committee on Taxation. (May 7, 2007). Further, section 530(e)(4) expressly includes the Taxpayers liberal burden of proof when requesting section 530 relief:
(A) IN GENERAL
- A taxpayer establishes a prima facie case that it was reasonable not to treat an individual as an employee for purposes of this section, and
- The taxpayer has fully cooperated with reasonable requests from the Secretary of the Treasury or his delegate,
then the burden of proof with respect to such treatment shall be on the Secretary.
Although the IRS has provided Taxpayers with vast information regarding the VCSP, and similar programs such as CSP, it is silent on the penalty-less framework of section 530. Unaware of other alternatives, Taxpayers continue to apply to the VCSP and consequently, voluntarily agree to be penalized where it may not otherwise be necessary.
If you have any questions regarding the Voluntary Classification Settlement Program, relief under section 530 of the Revenue Act of 1978, payroll taxes, or any other tax provision, please contact Fuerst Ittleman, PL at email@example.com.
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