The Internal Revenue Service has announced its Voluntary Classification Settlement Program (“VCSP”) offering relief to certain employers from unpaid employment taxes, penalties and interest that may result from misclassification of workers.  The IRS’s September 21, 2011, Announcement 2011-64 and “Frequently Asked Questions” (published on September 30) explains that the VCSP allows employers to correct misclassification issues on a prospective basis, while providing refuge from the possibility of audit and potential employment tax liability for past tax years.  Employers who want to participate in the VCSP must apply on Form 8952, agree to a three-year extension of the statute of limitations on employment tax assessment for the tax years commencing with the year of the VCSP participation election, pay all employment taxes due under the VCSP, treat the workers who are the subject of the VCSP as employees going forward, and enter into a closing agreement with the IRS.

Under the VCSP, an employer will pay only 10% of the reduced rate of employment tax provided under section 3509 of the Internal Revenue Code for the most recent tax year (in 2010, 10.68% for workers at or below the Social Security wage base). Participating employers will pay no penalties and no interest on unpaid employment taxes. An employer who misclassified workers and paid them $1,000,000 in 2010 for wages below the Social Security wage base, for example, would owe only $10,680 in employment taxes, rather than $106,800, plus interest and penalties, for that year.

To be eligible for VCSP, employers must have treated the misclassified workers as non-employees consistently in past years, have filed Form 1099s for the previous three years, and not currently under audit for worker classification issues by the IRS, Department of Labor or any state government agency.  Employers who have been audited worker classification issues in the past may participate in the VCSP only if they complied with the terms of the agencies’ determinations or closing agreements resulting from the audits.

On its face, the VCSP seems a good deal. However, employers should proceed with caution.  Executing a closing agreement with the IRS does not resolve potential liability arising from worker misclassification under federal and state minimum wage and overtime laws, state unemployment compensation and workers’ compensation statutes, or laws pertaining to employee benefits under ERISA.  Given the policy of “information sharing” by and between state and federal agencies, the employer who carelessly runs to the VCSP program without due consideration may find itself facing substantial unintended, and unwanted, consequences—falling like Alice down the rabbit hole to a place not much like “Wonderland.”