Did you misclassify your employees as independent contractors? If you’ve been following my blog, you should know by now it’s likely not being used correctly.

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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Now that we’ve gone over the SSWB, we can illustrate how the VCSP works by showing examples.

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.

Can you see how fast that adds up? Audits are nasty and tremendously expensive. I’ve been meaning to show you just how expensive they can be, but haven’t had time until now. Are you convinced yet that intentionally misclassifying workers is a bad idea?

Anyways, the VCSP drops that amount down to just 10% of that ($4,112), only holds you liable for that one year of employee tax, eliminates the penalties, and keeps you from being audited in the future for the same employees. It pays to turn yourself in.
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Let’s assume that you didn’t file your workers’ 1099’s. If you elect to participate in the VCSP TEE program, the maximum amount you will owe in this particular scenario is $15,910 (give or take depending on how many 1099’s you failed to file). If you had filed Forms 1099 for these workers for each of the past three years, you would be able to apply under the regular VCSP program and save yourself around $10,000 (again, depending on the number of 1099’s you failed to file, since that penalty is calculated per unfiled document).
As always, if you have any questions, please email me or comment below. I’m happy to help. If you know of an owner that might qualify for the VCSP, share this information with them. It could save them a substantial amount of money.

5 COMMENTS

  1. I just found out that I wrongly classified my workers for the last two years but I have been treating them as independent and doing their 1099 forms, so I qualify! I’m calling a tax attorney this afternoon and to get rolling on this! THANK YOU SO VERY MUCH FOR THIS! YOU ARE A BLESSING!

  2. How would this work if you are an employee who was misclassified? I filed 1099’s for 5 years under a previous employer. Many of the violations listed were (and still are) being committed in that salon. My sister is still working there at this time but I am opening my own salon and she will be moving with me soon. All this information has been extremely helpful but I’d love more information on how she and I would go about rectifying this ourselves. Thank you!

  3. Hi! I just began training to become an educator for a global brand. The things they had us sign, the conditions and exclusivity, “strongly encouraging” us to buy all the same tools, not allowing us to use anything with another brands name on it or speak of other brands, retaining rights to all the work we do under their name, telling us what job to do but not covering all expenses, etc etc all feels a lot like employee to me. And they classify us as independent contractor. I have just completed my phase 1, and technically haven’t been accepted yet. But after experiencing what I did during training, I do not want to be accepted. And I would like to report them. How do I do this when I haven’t been paid for a job yet? I want to stop the exploitive tactics they use and the con job they run on stylists. It seems they use and abuse them until they wise up and leave. With no repercussions to the company. It’s wrong. Thank you.

    • In the US, it’s hard to report exploitative employers if you haven’t been directly exploited with them. The best you can do is warn other educators and encourage them to do something about it, but this issue (particularly in the US) is pervasive to the point that nearly all major brands here do it. Oddly, they don’t appear to do so in countries with stricter labor and employment classification regulations.

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