IRS Offers Employers Misclassification Amnesty: Come in to My Parlor Said the Spider to the Fly

On September 21, 2011, the Internal Revenue Service (“IRS”) announced its new worker misclassification amnesty program, which is designed to encourage employers that have wrongly classified any of their workers to come forward and correctly classify their workers as employees going forward.  Officially called the Voluntary Classification Settlement Program (VCSP), the program is the IRS’s attempt to “enable many employers to resolve past worker classification issues and achieve certainty under the tax law at a low cost by voluntarily reclassifying their workers”.  So, what kind of deal is on offer in this amnesty program?  Basically, the IRS is offering a settlement that will allow employers to pay an amount equal to about only 1% of wages paid to the misclassified workers over the past 12 months, plus it offers to waive all penalties and fees that would otherwise be due.  If you are an employer with a misclassification cloud looming over your head, this represents a major opportunity to get into compliance and clean up your act.  So, how can you get in on the deal?

According to the IRS’s announcement:

To be eligible, an applicant must:

  • Consistently have treated the workers in the past as nonemployees,
  • Have filed all required Forms 1099 for the workers for the previous three years
  • Not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers

Fairly straight forward, right?  Big discount, and an easy process.  What’s not to like about it?  So, you ask, why the reference to the spider and the fly in the title of this article?  Well, although federal tax liability for worker misclassification can be a large sum of money, employers also need to be concerned about state taxes, federal and state wage & hour violations, back benefits, workers compensation and unemployment contributions.  These amounts can be huge, and can be doubled by liquidated damages in some instances. The IRS VCSP deal has no bearing on these other major obligations.

“So what?” you say, “Everybody knows that government agencies don’t talk to each other! I’ll cut a deal with the IRS, and then let the misclassification issue fade away like a distant memory.”  There was a time not so long ago when such a strategy may have been sound, but now things are vastly different.  Why? because as nice as the IRS seems to be in offering this great looking deal, once you come forward and take advantage of the program, they will be having a chat with certain other government agencies that do not intend to be quite so nice to you.  Specifically, the IRS will be sharing information about its misclassification cases with the federal Department of Labor (DOL) and eleven state DOLs, as announced by Secretary of Labor Solis and IRS Commissioner Shulman on September 19, 2011.  The states that are, or will soon be, included are Connecticut, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, Missouri, Montana, New York, Utah, and Washington.

Suddenly, the IRS deal doesn’t look so great any more.  Indeed, now it looks like an invitation into the spider’s parlor!  Admittedly, for employers with serious and numerous misclassification concerns, the IRS deal could still be a good option.  However, the choice becomes (1) do absolutely nothing, and gamble that neither the IRS or DOL audits them, or (2) stay under the radar but try to simply convert the misclassified workers to employees on their own, risking the workers waking up and filing a claim in court or with the DOL (which will now call the IRS and state DOL!), or (3) take the IRS amnesty deal AND get hammered by the various government agencies that will surely descend on them after taking the IRS deal.  The first and second options roll the dice in the hope that nobody finds out, but risks maximum exposure to tax, wage, and insurance liabilities.  The third offers substantial tax discounts, but all but guarantees exposure to wage, and insurance liabilities.  Neither option is particularly appealing since all involve paying potentially large sums of money.

However, misclassification is a serious problem that needs to be corrected (as I have mentioned before).  Considering the newly announced plan for inter-agency cooperation, and the new amendments to the New York wage and hour law, employers should clean up their misclassification issues sooner rather than later.  With enhanced criminal penalties and 100% liquidated damages for wage violations committed after April 2011, the stakes are much higher for New York employers now.  Still, each employer’s situation is different, making it imperative that they conduct a full legal and strategic analysis before choosing a particular course of action.  As such, employers considering the IRS VCSP should first consult with experienced labor and employment counsel.    Above all, they need to recognize that as good as the IRS VCSP may ultimately be for certain employers, it is far less appealing than it first appears, and comes with significant strings attached.  In short, they should definitely look this gift-horse in the mouth! 

With the experience and expertise of a large law firm, and the flexibility and lower costs of a small law firm, Reid Kelly, P.C. is committed to ensuring that small companies, and not-for-profits, have access to competent representation in labor, employment, and immigration law matters at rates that are reasonable and affordable.  For more information, call us at (718) 412-8452.

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One Response to IRS Offers Employers Misclassification Amnesty: Come in to My Parlor Said the Spider to the Fly

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