If you’re a California taxpayer and business owner, chances are you’ve heard of the EDD audit. This occurs when the California Employment Development Department (EDD) launches an investigation into a business’ California state payroll tax records to determine if the business has classified a worker as an independent contractor instead of an employee. The EDD can personally assess you for “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees. And if you’ve ever hired an independent contractor, you could be facing this tax audit.
If you’re facing an EDD audit, the last thing you want to worry about is the prospect of an IRS audit as well. Fortunately the Voluntary Classification Settlement Program (VCSP) can help. The VCSP is a program developed by the IRS that allows taxpayers to voluntarily reclassify their workers as employees for future tax periods for employment tax purposes. This is significant because under the VCSP, a taxpayer will pay 10 percent of the amount of employment taxes that would have been due on compensation paid to the workers being reclassified for the most recent tax year. Additionally, the taxpayer is not liable for interest and penalties on the payment under the VCSP and will not be audited for employment tax purposes for prior years. So if you’re facing an EDD audit, you can choose to voluntarily disclose to the VCSP and pay much less than what you’d face in a full audit.
In order to qualify for the VCSP, a taxpayer must treat the workers to be reclassified as independent contractors or other non-employees and have consistently treated the workers as nonemployees. This includes them having filed Forms 1099 for at least three years (as opposed to W-2 forms).
How to Apply to the VCSP
Individuals must apply for the VCSP by submitting Form 8952, Application for Voluntary Classification Settlement Program. The form should be filed at least 60 days from the date the taxpayer wants to begin treating its workers as employees. The VCSP will notify the taxpayer if they’ve been accepted to the program.
If a taxpayer is accepted, they must agree to treat the contractors as employees for future tax periods for employment tax purposes. They will then not be subject to an employment tax audit with respect to the worker classification of the workers for prior years. The taxpayer will pay 10 percent of the employment tax liability, calculated at the reduced rates of IRC section 3509(a). That amount is due to the VCSP when they return the signed closing agreement to the IRS.
An audit, either by the EDD or IRS, is a frightening proposition. The VCSP allows taxpayers to lessen their IRS audit risk by voluntarily reclassifying a contractor as an employee and paying the 10 percent fee. An experienced tax attorney or professional can help you complete the VCSP application and prepare you if you think you may face an EDD or IRS audit. Don’t try to deal with the IRS on your own.
Allison Soares is a partner and tax attorney at Vanst Law. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.