Special analysis: Tax relief in misclassification cases

The IRS is not in the business of collecting the same taxes twice. This is key in worker misclassification cases. If misclassified workers pay their income and self-employment taxes, you’re off the hook for the income taxes you didn’t withhold and likewise for both the employer and employee portions of FICA (but penalties may still apply).

Snag: You can’t demand that these individuals show their 1040s, so how can you prove they paid their taxes? A recent case and IRS guidance may hold some of the answers.

Tax court OKs disclosure of return information. To prove that the taxes were paid, standard operating procedure requires you to obtain signed Forms 4669, Statement of Payments Received, from your misclassified workers. Problem: What if they’ve moved on and you can’t find them?

That’s what happened to one employer, after the IRS reclassified its independent contractors. When it couldn’t get signed forms from 70 workers, it wanted the IRS to scour its records to see if any of them paid their taxes. The IRS objected on taxpayer privacy grounds, but the Tax Court allowed it.

Tax Court: The big picture here is that if these individuals paid their taxes, the employer’s case would be entirely resolved. Their return information, therefore, is disclosable to the employer, the court ruled. (Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11, U.S. Tax Court, 2017)

Form 4669: Not a get-out-of-jail-free card. Taxpayer privacy is sacrosanct, and the IRS is interpreting Mescalero so narrowly that it will apply exclusively in Tax Court cases. Upshot: Your only realistic avenue for getting the IRS to abate the taxes these individuals paid is to have them complete Form 4669. You should document these efforts. After receiving the forms back, attach them to Form 4670, Request for Relief of Payment of Certain Withholding Taxes, to request an abatement.

You can try to prod the IRS into opening its files for those who didn’t respond to your request by preparing a spreadsheet of those missing payees, the amounts you paid them, the dates you paid them and the amount eligible for an adjustment. (IRM 4.23.8.4.3)

VCSP: Almost a get-out-of-jail-free card. Under the IRS’ Voluntary Classification Settlement Program, you may voluntarily reclassify independent contractors as employees for future tax periods. Timing matters: You must reclassify workers before the IRS audits your tax treatment of those workers. As a financial incentive to participate, the IRS won’t assess penalties or interest with regard to your voluntary reclassifications. Instead, you will be liable for just over 1% of the wages paid to your reclassified employees for the past year.

To participate, file Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before you want to change workers’ status. The IRS retains discretion to accept your application. If it accepts your application, you will be required to enter into a closing agreement and pay the full amount due.