The Internal Revenue Service (IRS) has developed a new program called the Voluntary Classification Settlement Program (VCSP) that permits taxpayers to voluntarily reclassify workers as employees for federal employment tax purposes. Taxpayers that choose to participate in the program and voluntarily reclassify workers as employees for future tax periods will only have to pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year; will not be liable for any interest and penalties on the liability; and will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years. Additionally, a taxpayer participating in the VCSP must agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

To participate in the program, the taxpayer must have consistently treated the workers as nonemployees, and must have filed all required Forms 1099 for the workers for the previous three years. The taxpayer cannot currently be under audit by the IRS, the Department of Labor or by a state government agency. A taxpayer that previously was audited by the IRS or the Department of Labor concerning the classification of the workers will only be eligible if the taxpayer has complied with the results of that audit.

So, what’s the catch? Though this program may help taxpayers avoid federal employment tax obligations, it potentially opens them up to a wide range of liability in cases that almost certainly will be brought against them by the DOL and the newly classified employees themselves. In fact, on September 19th, the IRS and DOL entered into a memorandum of understanding according to which they agreed to an information sharing initiative to fight worker misclassification. Therefore, while the federal government offers its one hand in friendship, it smacks – and smacks hard – with the other.

One would hope that any taxpayer agreement with the IRS to participate in the VCSP would include a non-admissions clause. Nevertheless, every worker that is re-classified as an employee will be alerted to the potential past misclassification and undoubtedly will pursue every avenue available to them to obtain whatever back wages and benefits they think they may be entitled to.

It is this fear of the potential liability looking backwards that has always kept good businesses from adjusting potentially questionable classifications in the past. Making these adjustments can be tricky and very fact specific, so it is best to contact your employment attorney before agreeing to participate in the VCSP.