The Safe Haven and Voluntary Classification May Save Your Business From the IRS.
Recently, under the Trust Fund Recovery Act (TFRA), the IRS has made it a priority to target businesses which misappropriate funds collected from employees for the purpose of paying payroll taxes. The risk is not limited to losing one’s business, the IRS can impose personal liability and criminal charges upon any “responsible person” for a business’s failure to pay payroll taxes.
IRS investigations are complex, and defending any lawsuit costs everyone involved time, stress, and money. The risks aren’t even limited to owners of a business, but to officers or employees, partners, corporate directors, shareholders, members of a board of trustee, and even payroll service providers. It is vital that all responsible parties strive to ensure that all payroll tax funds are properly applied, and that all persons providing services to the business are properly applied as employees or independent contractors. The right to direct or control the work being done is the primary consideration in determining the difference. The IRS website, defines independent contractors as someone who “has the right to control or direct only the result of the work and not what will be done and how it will be done.”
The IRS website instructs that businesses can avoid the stiff penalties under TFRP by making sure that all employment taxes are collected, accounted for, and paid to the IRS when required. However, the law also provides a “Safe Haven” rule that can minimize uncertainty when it comes to the proper treatment for purposes of employment taxes.
If a business satisfies all of the elements under the rule, their characterization of an individual as an independent contractor is not likely to be challenged. The rule allows employers to effectively “reclassify” as an employee an individual who had previously been improperly classified as an independent contractor. This is only allowed if the employer has filed all required federal tax returns and had a “reasonable basis” for not treating the individual as an employee.
In other words, if you have always treated a certain worker as an independent contractor and properly filed the corresponding tax returns, you may be in the clear.
As always, the devil is in the details. For example, what's a "reasonable basis" for not treating someone as an employee? In general, there are three things that can be used to support such a claim.
- The employer can cite some legal precedent - a judicial ruling, public statements of guidance by the IRS, or a letter of advice or ruling privately received from the IRS,
- An employer can point to a past audit by the IRS in which workers holding similar positions to current employees were deemed to have been properly classified, and
- Finally, the business owner can show that there is a long-standing and recognized practice of a "significant segment" of an industry in which certain kinds of workers tend to be classified in a certain way.
Legislation in this area has clarified and added to the requirements for qualifying for the safe haven. The new rule clarifications include:
- • Employers who seek to rely on a prior audit must show that the audit upon which it relies specifically examined the issue of the classification of a worker with a substantially similar position,
- • To prove that a "significant segment" of an industry treats a certain kind of worker as independent contractors requires a showing of no less than 10%, but perhaps not quite 25%, of an industry engaging in such practice,
- • 10 years will usually be enough for a practice to be considered “long standing,” though it may be fewer years depending upon the particular facts and circumstances. (In practice this clarifications serves mostly to encourage new industries to take advantage of the safe haven rule relief,
- • For audits beginning after 1996, IRS employees must, at the beginning of an audit involving worker classification issues, provide the business with written notice of the safe haven provisions, and
- • Once established that a business had a “reasonable basis” not to treat a worker as an employee under the safe haven rule, the burden of proof shifts to the IRS as to the treatment of that worker, for purposes of the safe haven rule.
Don’t Qualify? Don’t Panic. The Voluntary Classification Settlement Program
If you don't satisfy the provisions of the safe haven rule, but you suspect you’ve improperly classified employees, there are still options available to protect your interests.
Business which are not currently involved in an IRS audit or lawsuit, or other challenge may take advantage of the Voluntary Classification Settlement Program (VCSP). This program allows eligible companies to prospectively reclassify independent contractors as employees with no audit exposure and minimal liability for past taxes. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, enter into a closing agreement with the IRS, and agree to appropriately treat workers as employees in the future.
Also available to businesses who are struggling to determine how to properly classify an individual is Form SS-8. Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS, by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
Don’t Delay, Consult The Tax Lawyer
The IRS considers improper classification of an employee as an independent contractor to be an area of significant noncompliance. Small business owners, often lacking the resources to implement internal control systems and safeguards, can be especially vulnerable to prosecution under the TFRA. The US Tax Code is one of the most complicated that has ever existed. Even the most honest, competent, and diligent of employees face countless opportunities to run afoul of the IRS. It is crucial to have proper guidance by an experienced tax attorney in making key business decisions.
If you are undergoing an IRS audit involving worker classification issues, or anticipate that an audit may be on the horizon, it is wise to retain experienced legal counsel and take great caution in how you respond to the IRS. William D Hartsock has been successfully helping clients resolve business tax issues and payroll tax matters since the early 1980's. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule your free consultation simply fill out the contact form found on this page, or call (858)481-4844.