In the article "Is Your Freelancer Really Your Employee?" we talked about why your misclassified employees are upset with you — and are turning you in to the Internal Revenue Service (IRS). So, now that your odds of being audited have dramatically increased, what can you do to avoid the penalties? Participate in the Internal Revenue Service's Voluntary Classification Settlement Program (VCSP).
First of all, what are the penalties?
The IRS typically goes back to audit your books for at least three years. But… if you have never filed payroll tax returns or issued Form 1099-MISC at all for the people you pay, they can go back to the beginning of your business. Though, generally, they won't go back for more than six years.
Based on the compensation the IRS thinks should have been payroll, these are the penalties they will assess for each of those years:
- Effective tax rate of 10.68 percent (10.28 percent for 2011 and 2012) per year per employee.
- Late payment penalty of 10 percent of the entire balance due.
- Late filing penalty of 25 percent of the entire balance due.
- Interest on the taxes and all the penalties.
- State taxes. The IRS will provide a copy of the audit to the state. The state will assess their own set of taxes, penalties, and interest.
Considering that these taxes, penalties, and interest will also apply to the working shareholder of a corporation or S corporation, in addition to the employees, this bill can wipe out a company.
The IRS' amnesty program, called the Voluntary Classification Settlement Program for Employers (VCSP). The application for this amnesty is filed using Form 8952, Application for Voluntary Classification Settlement Program (VCSP). You must file this form at least 90 days before you want to convert your workers to employees — and fix all your payroll problems. For instance, if you wanted to start on July 1, you need to apply by April 1.
What benefits do you get if you file — besides amnesty?
- You will 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, determined under the reduced rates of section 3509(a) of the Internal Revenue Code.
- You will not be liable for any interest and penalties on the amount; and
- You will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.
- The IRS will NOT notify the state about the arrangement or give them a copy of the details. So this won't automatically generate a state audit. Beware, once you start filing payroll taxes with the state, they might ask questions about the past. This is a serious consideration to take into account.
Not all employers will qualify for the amnesty program. You do have to meet certain criteria. One of which is, you cannot already be under audit. Step up quickly before your employees turn you in.
For those employers who do apply for the VCSP, the savings can be substantial. For example, take a calculation based on unreported payroll of $625,000 in the prior year. Under the amnesty, the full payment to the IRS would be under $6,600. Without the amnesty, with the IRS looking back for only three years, it would cost the employer over $292,000 (for six years, over $620,000).
Believe it or not, the IRS would prefer to have you participate in this program than be forced to audit you or chase after you. They want it so much that they have made this a permanent amnesty. There is no deadline to apply.
About the Author
Eva Rosenberg, EA is the publisher of TaxMama.com. Get your tax questions answered for free in the TaxQuips Forum. Eva is the author of several books and e-books, including Small Business Taxes Made Easy. Eva teaches tax courses at IRSExams.com and CPELINK.