Some owners intentionally misclassify their employees for their own benefit to avoid employment tax and compliance with other employment laws. Intentional misclassification is a crime.
However, some owners commit these crimes out of sheer ignorance. They either followed some ridiculous message board advice or emulated another salon owner they worked for. In some cases they took the advice of someone they assumed they could trust (like an accountant) without realizing that person wasn’t qualified to advise them.
Whether the crime was committed intentionally does not change the way it is treated by the IRS or DOL.
The only way you can hope to get some measure of clemency from the IRS is to come clean before you’re caught.
Personally, I like this system because it rewards honesty. It is called the Voluntary Classification Settlement Program (VCSP). If you recognize that you’ve made a mistake and you approach the IRS about it before a labor dispute, employment tax audit, or lawsuit is launched against you, the IRS will go easy on you.
If you agree to correct the mistakes, the IRS will only require you to pay 10% of the employment tax liability that would have been due on those workers for the most recent tax year. In addition, you won’t be held liable for any interest and penalties on that amount. Believe it or not, this deal actually gets sweeter: the IRS will not subject you to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years. (As a sidenote, pay close attention to that wording. “…of the workers being reclassified under the VCSP for prior years.” This means that you likely need to include every employee you have ever misclassified for this condition to apply.)
There are some eligibility requirements you must meet.
- You must want to voluntarily reclassify your workers as employees for all future tax periods. If you’re interested in the VCSP, I think it’s safe to assume that you want to put things right for now and in the future.
- You must have consistently treated your workers as nonemployees and be treating them as nonemployees at the time of filing. If you are putting your workers on a schedule, dictating to them, having them sign employment contracts, or committing any of the other common abuses of control, this will likely make you ineligible, but consult with an attorney to be sure.
- You must not be under employment tax audit by the IRS or under audit concerning the classification of the workers by the DOL or any other state government agency. (You shouldn’t have been caught yet, basically.)
- You must have no current dispute with the IRS regarding employment status.
- You must not have been audited by the IRS in the past for worker classification OR if you have been audited previously by the IRS or DOL, you will only be eligible if you have complied with the results of that audit and not currently contesting the classification in court. If you’ve been ruled against in a classification suit and have gone on to commit the same crimes, you will likely not be eligible. (The IRS assumes you should have learned your lesson after the last audit.)
- You must have filed all required Forms 1099 for the workers to be reclassified under the VCSP for the period of time that the workers have worked for you. This eligibility requirement is not a total dealbreaker.
If you don’t meet the eligibility requirements because you failed to properly file 1099’s, there is another “tax amnesty” program you might be able to benefit from. It is called the Voluntary Classification Settlement Program Temporary Eligibility Extension (VCSP TEE, the IRS loves their acronyms). With the exception of the 1099 filing requirement, the eligibility requirements are identical to that of the VCSP, however, the tax rate is higher under the VCSP TEE than the VCSP (25% as opposed to 10%) and reduced penalties are applied for each 1099 you failed to file. Don’t complain about that additional 15% or the fees. That’s the price you pay for failing to comply with the IRS information reporting requirements–and it’s a small price to pay considering what you would have been hit with if you hadn’t stepped forward on your own.
Before I give examples, I have to briefly explain what the Social Security Wage Base is. The SSWB is the maximum earned gross income or upper threshold on which a wage earner’s SS tax may be imposed. So, if your employee makes an amount that exceeds that threshold, you both are only required to contribute up to the amount set by the SSWB. All income in excess of the SSWB is not subject to SS tax. Remember, SS is one component of FICA. The other is Medicare (which does not have a threshold–all income is subject to Medicare tax). In 2014, the SSWB was $117,000 and the SS tax rate for employers and employees alike was 6.2%. (Each of you contribute 6.2%, not 6.2% split between the two of you.) So, if your worker received $125,000 in compensation for 2014, you would subtract $117,000 from $125,000. That $8,000 dollars is not subject to SS tax.
I know, it’s a little confusing, but I’m working really hard to put this into plain English, lol. Hopefully, you’re still following me.
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Let’s say your employees’ total compensation for the year was $400,000 and none of their individual incomes exceeded the $117,000 SSWB. At the very least, if audited, you will owe $47,720 (10.68% of $400,000). That’s without your fees and penalties. You will owe a similar amount for previous years for which the workers were misclassifed.
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