The IRS has announced a new program to bring employers that have misclassified employees as independent contractors into compliance. The Voluntary Classification Settlement Program (VCSP) offers a reduced penalty framework and audit protection exchange for employers voluntarily reclassifying their workers for federal employment tax purposes.

Worker classification

The distinction between employee and independent contractor has important federal tax consequences. An employer must generally withhold income taxes, and withhold and pay Social security and Medicare taxes, along with unemployment tax wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors. Independent contractors are self-employed individuals.

The IRS has discovered abuses by employers. Certain industries, for example the construction trades, have more misclassified workers than others.  In response, the IRS developed the VCSP.


The VCSP, like other recent IRS initiatives, uses a carrot and tick approach. In exchange for agreeing to prospectively treat workers as employees for future tax periods, employers:

–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 Code Sec. 3509(a).

–Will not be liable for any interest and penalties on the amount; and

–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.

Who may participate?

The IRS has opened the VCSP to employers currently treating their workers as independent contractors or other nonemployees,  that want to prospectively treat the workers as employees. The employer must have consistently treated the workers as nonemployees. Additionally, the employer must have filed all required Forms 1099 for the workers for the three preceding calendar years.


Although the VCSP is generous, there are some limitations. The employer cannot currently be under audit by the IRS or DOL. An employer previously audited by the IRS or DOL may be eligible for the VCSP if the taxpayer has complied with the results of that audit. Exempt organizations are eligible to participate in the VCSP unless the organization is currently under a Form 990 series examination.

Additionally, the employer must agree, for the first three years under the program, that taxpayers are subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. An employer may refuse to extend the limitations period or to limit the extension to particular issues. However, the IRS will not enter into a VCSP with that employer.

If you have any questions about the VCSP, please contact our office. The IRS is devoting significant resources to curbing misclassification of workers. The VCSP is likely not to be the last initiative in this area from the IRS.

IR-2011-95, Ann. 2011-64, IRS FAQs