Change Independent Contractors into Employees Trouble-Free

Tax Planning

You have read horror stories about how the IRS audits business owners and deems their 1099 independent contractors W-2 employees—and then assesses tens (or hundreds) of thousands of dollars in back payroll taxes, interest, and penalties.

Are you one of those horror stories?

Okay, let’s say you are one of them. You know that you are an IRS target because you have workers who really should be employees, but you treat them as independent contractors. And you are afraid that if you change now, the IRS will see that change, audit your prior years, and charge big bucks for your mistake.

What should you do? Keep the workers as independent contractors and hope the IRS doesn’t catch on? Or amend your past returns to show the misclassified workers as employees?

Depending on how many workers you have misclassified, and the number of years involved, that amendment process could be cost prohibitive.

But be happy you are reading this article. It will show you how the IRS offers a way for you to come clean, reclassify your workers correctly, and pay only pennies on the dollar for your past bad deeds.

The Pennies-on-the-Dollar Come-Clean Program

The come-clean program, which should have you paying just pennies on the dollar, is the IRS Voluntary Classification Settlement Program (VCSP) for business owners who want to change their worker classification on a going-forward basis.

Not everybody qualifies for the VCSP. To be eligible to participate in the VCSP, you must meet the following requirements:

  1. Reporting consistency. You must have timely filed the previous three years’ federal tax returns for your workers (that is, 1099s) consistent with your treatment of the workers as independent contractors.
  2. Not currently under audit. You cannot currently be under employment tax audit by the IRS, or under worker classification audit by the Department of Labor, or any state government agency.

Benefits of the VCSP Settlement Agreement

If you decide to participate in the VCSP, you must agree to treat the class or classes of workers covered by the agreement as employees for future tax periods. In exchange, you will receive the following most-favorable benefits:

Reduced employment tax liability. You pay only 10 percent of the employment tax liability that

would have been due on compensation paid to the workers for the most recent tax year.5 (Pennies on the dollar for one year—about 3.3 percent of what that likely was for the past three years.)

No interest or penalties. You will not be liable for any interest and penalties. (Okay, knock that 3.3 percent down to something like 0.93 percent.)

Audit protection for misclassifications in prior years. You will not be subject to an employment tax audit for prior years with respect to the workers covered by the VCSP. (Priceless.)

If you have misclassified workers, there is very little downside to participating in the VCSP—except, of course, that you will have to treat the workers covered by the VCSP agreement as employees on a going-forward basis.

How to Apply for the VCSP

You must apply to participate in the VCSP by using IRS Form 8952, Application for Voluntary Classification Settlement Program. You should file the application at least 60 days prior to the date when you want to begin treating your workers as employees.

The IRS will make every effort to process your application in sufficient time to allow for the voluntary reclassification on the requested date.

If you are accepted into the VCSP, you enter into a closing agreement with the IRS to finalize the terms of the VCSP and make full and complete payment of the amount due.


Here are some key insights from this article.

The IRS VCSP offers a pennies-on-the-dollar chance to change the classification of your workers from 1099 to W-2 on a going-forward basis.

  1. To be eligible for the VCSP, you cannot be currently under audit for employment taxes or worker classification by the IRS, or under worker classification audit by the Department of Labor, or any state agency.
  2. You must have filed 1099s for your independent contractor workers for the most recent three years.
  3. The VCSP agreement results in a minimal employment tax liability, and no penalties or interest.
  4. VCSP agreements are closing agreements that are binding for future tax periods. 

Of course, the downside is that those workers are now W-2 employees.

Christopher Ragain

My name is Christopher Ragain, I am the founder of Tax Planner Pro.  I love helping small business owners find creative and legal ways to beat the TaxMan.  My team and I love to write and you can find all of our insights on this blog!

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