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Tax Tip: Classify Workers Correctly to Satisfy the IRS

Posted: July 9, 2013, 3:00 p.m. EDT

By Mark E. Battersby

A recent Department of Labor study revealed 30 percent of businesses misclassified employees as independent contractors. Whether it’s a pet shop labeling a groomer as an independent contractor or some other misclassification of a worker as a "nonemployee,” this error all too often results in liability not only for employment taxes but also for a 100 percent penalty for failure to collect and account for those employment taxes.

Late in 2011, the Internal Revenue Service launched a new Voluntary Classification Settlement Program, or VCSP, that allows employers to prospectively reclassify workers previously (and erroneously) labeled independent contractors or other nonemployees as employees.

Hiring workers as contractors could mean more money in your wallet. Thinkstock


Any pet dealer accepted into the VCSP agrees to prospectively treat the class of workers as employees for future tax periods and in exchange:

• 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;
• Won’t be liable for any interest and penalties on the liability;
• Won’t be subject to an employment tax audit for prior years; and
• 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.

Although a pet business could be audited for another reason, the IRS’s rejection of a VCSP application will not automatically trigger a federal tax audit. Also keep in mind that the VCSP concerns future years only. Thus, a business signing a VCSP closing agreement is not admitting liability or wrong-doing for past periods.

As a reward, employers accepted into the VCSP program generally will pay an amount equal to slightly more than one percent of the wages paid to the reclassified workers for the past year.

Under the newly expanded VCSP program, employers currently being audited (other than an employment tax audit) can qualify for the VCSP. Of course, to be eligible for the VCSP, an employer must currently be treating workers as independent contractors or nonemployees and consistently have treated them as such in the past.

In today’s tough economy, employers are looking for every possible way to stay competitive and get the work done. Choosing to classify workers as independent contractors can be a money saver, but it’s also a huge IRS target and can end up costing employers more than they saved. And, not to mention, there are often criminal penalties in the worst cases.

While the IRS’s recently expanded VCSP may provide an answer for some pet dealers, breeders, distributors and manufacturers caught up in the ongoing employee versus independent contractor brouhaha, this is one area in which a little thought, a little preparation and professional guidance can be better than a cure. <HOME>


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