The Internal Revenue Service is not noted for charity toward miscreants whose tax returns are, shall we say, creative. It was tax evasion, after all, rather than murder, bootlegging, and assorted other crimes, that led to a federal conviction for mobster Al Capone. Every now and then, though, the IRS manages to give a real break to taxpayers who might have made an honest mistake.
The agency’s Voluntary Classification Settlement Program (VCSP), announced a few months ago, is such a break for employers who qualify. The program applies to employers across the board and is not restricted to the horse business. The potential savings under the program could be huge.
Before you read any further—STOP! Raise your right hand and promise that you will not take this information as legal advice. Not every employer will qualify for VCSP, navigating the requirements of the program is tricky, and it’s not at all clear whether individual states are buying into the federal tax forgiveness scheme. Figuring this out isn’t a do-it-yourself project! Professional guidance from a tax advisor knowledgeable about taxes and the horse industry is essential.
What’s the Problem?
The issue for the IRS is accurate classification of workers as either employees or independent contractors.
If a worker is an employee, the employer must withhold taxes from the worker’s pay and provide a W-2 Form at the end of the year. The worker then must file a tax return with the IRS to get a refund of any excess withholding. Most of us are familiar with this process.
If a worker is an independent contractor, on the other hand, there is no withholding and far less administrative red tape for the employer. Instead, the red tape is passed along to the independent contractor, who is required to estimate the tax due and make periodic payments to the IRS in lieu of employer withholding. An independent contractor receives a 1099 Form at the end of the year and can file for a refund like an employee.
In theory, it should be a wash, with either the employer or the independent contractor sending money to the IRS. Both withholding and estimated tax payments amount to interest-free loans from workers to the government, which has an interest in taxpayer compliance.
In fact, at least according to the IRS, too many workers that should be classified as employees subject to withholding actually are being treated as independent contractors by their employers. This apparently is a problem for the IRS. If independent contractors are not be as diligent about making estimated tax payments as employers are about withholding taxes from employees, less money makes its way into government coffers.
There can be major financial ramifications for an employer who mischaracterizes an employee as an independent contractor, whether the error is intentional or inadvertent. Add together the tax that should have been withheld, interest on that amount, and penalties, and an employer can be on the hook to the IRS for some serious money.
What’s the Solution?
The VCSP allows employers who have been mischaracterizing their employees as independent contractors a way out of the potentially pricey predicament without payment of all the back taxes, interest, and penalties that otherwise would be due.
Employers who want to participate must meet the following criteria:
●They must have treated the workers as independent contractors in the past;
●They must have filed all required 1099 Forms for the last three years;
●They must not be under audit by the IRS, the Department of Labor, or a state agency relating to the classification of the workers in question.
In return for a guarantee that the workers will be treated as employees rather than independent contractors in the future, employers will be assessed a small percentage of the total tax due, generally with no interest or penalties. Participating employers will not be audited by the IRS for payroll taxes related to the workers for past years.
Having the IRS take less rather than more sounds too good to be true. And it might be, because there is no guarantee that your state will go along with the tax forgiveness plan. It’s possible that in some circumstances, admitting an error might cause more problems that it solves.
The VCSP is part of a larger "Fresh Start" initiative by the IRS aimed at bringing taxpayers and businesses into compliance with a very complicated tax code, and not coincidently, generating more money. Participation in the program might be a good idea—or a bad one—depending on your situation. Get professional advice before deciding. General information about the program is available at www.irs.gov.
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