Worker classification has long been an area only vaguely understood by many employers. The law is not only not settled, it’s unclear, going all the way back to the common law of England.

Of course, there are benefits to treating a worker as an independent contractor rather than an employee. It allows the employer to avoid FICA and FUTA matching, and income tax withholding. And workers may be motivated to be misclassified as independent contractors so that they can be paid in cash, avoid withholding of taxes, or avoid proving immigration status.

Although there’s no bright-line test as to whether a particular worker is an employee or an independent contractor, the consequences of misclassification, whether inadvertent or deliberate, can be severe. The employer may be liable for the employer’s share of employment taxes, as well as penalties and backup withholding.

Generally, a person is an employee if he or she is subject to another’s right to control the manner and means of performing the work, while independent contractors obtain customers on their own to provide services to and are not subject to control over the manner by which they perform their services.

For employers that suspect they are paying individuals as independent contractors who might be considered employees, the IRS has offered a Voluntary Classification Settlement Program since 2011 under which taxpayers can prospectively reclassify their workers with very limited additional federal employment tax liability for past misclassification.

The Service recently expanded its VCSP, so that more taxpayers can take advantage of it (see IRS Allows Greater Flexibility in Voluntary Worker Reclassification Program). Several eligibility requirements have been eased, making it possible for more employers, especially larger ones, to apply. And employers accepted into the program will no longer be subject to a special six-year statute of limitations rather than the usual three years.

When the VCSP program was originally set up, employers that failed to file Forms 1099 for workers they were seeking to reclassify for the past three years were excluded from the program. But under the expanded program, until June 30, 2013, the IRS has waived this requirement.

To be eligible, an employer must currently be treating the workers as nonemployees; consistently have treated them in the past as nonemployees; and not be under audit on payroll tax issues by the IRS, the Department of Labor or a state agency concerning the classification of workers.

Employers accepted into the program will generally pay an amount just over 1 percent of the wages paid to the reclassified workers for the past year. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years.

Those employers applying under the temporary relief program who failed to file Forms 1099 will pay a slightly higher amount, plus some penalties, and will need to file any unfiled Forms 1099 for the workers they are seeking to reclassify.

Naturally, there are legitimate reasons for classifying workers as independent contractors, but for those employers who are uncertain, the temporarily expanded VCSP is a great deal. If you do misclassify and do not participate, it can amount to a bet-your-company cost, since you might wind up being hit with over 40 percent of total compensation paid to workers over three years. But for those that want to participate for workers for whom no 1099s have been filed, the clock is running. The expanded eligibility lasts only until the end of June 2013.

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