Rev. Proc. 96-59: The Classification Settlement Program

The Internal Revenue Service (IRS) offers two settlement programs for businesses that have misclassified workers as independent contractors: the Voluntary Classification Settlement Program (VCSP) and the Classification Settlement Program (CSP). These programs allow businesses to settle past federal employment tax obligations and correctly classify their workers going forward. They offer a way to avoid the full cost of back taxes and penalties by streamlining the resolution process.

The Voluntary Classification Settlement Program (VCSP)

The VCSP is a proactive program for businesses not currently under an IRS employment tax audit. It allows eligible taxpayers to voluntarily reclassify their workers as employees for future tax periods and receive partial relief from past-due federal employment taxes.

Eligibility for the VCSP

To participate, a taxpayer must have consistently treated the workers as non-employees and filed all required Forms 1099 for them for the previous three years. A business cannot be under an employment tax audit by the IRS, the Department of Labor, or a state agency.

VCSP Settlement Terms

Under the VCSP, a business agrees to reclassify its workers as employees for future tax periods. In exchange, the taxpayer pays 10% of the employment tax liability that would have been due on compensation for the most recent tax year. The IRS will not charge interest or penalties on this amount or audit the business for prior years regarding the reclassified workers.

How to Apply for the VCSP

Businesses must apply for the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program. This application must be filed before the business is selected for an employment tax audit.

The Classification Settlement Program (CSP)

The Classification Settlement Program (CSP) is available to businesses already under an IRS audit for worker classification issues. It allows for a settlement early in the examination process, based on criteria from Section 530 of the Revenue Act of 1978.

Eligibility for the CSP

To qualify for the most favorable settlement, a business must meet several requirements. The business must have filed all required information returns, like Form 1099-NEC, for the workers. It must also have a consistent history of treating these workers as independent contractors.

Finally, the business must demonstrate a “reasonable basis” for the classification. A reasonable basis can be shown by reliance on a prior IRS audit, a judicial precedent, or a long-standing industry practice.

The Settlement Offers

The CSP provides two settlement offers, both requiring the business to reclassify the workers as employees for future periods. The most favorable offer is for businesses that meet all eligibility criteria, including the reasonable basis test. Under this offer, the taxpayer pays a percentage of the employment tax liability for the most recent tax year under examination. The IRS will not charge interest or penalties or pursue employment taxes for prior years.

An alternative offer exists for businesses that meet reporting requirements but fail to establish a reasonable basis. In this scenario, the business pays the full employment tax liability for the most recent tax year being examined. This still provides relief by preventing the IRS from assessing taxes and penalties for preceding years.

Requesting a CSP Settlement

The CSP process is initiated by an IRS examiner during an employment tax audit, as a business cannot proactively apply. If the examiner determines the business is eligible, they will extend a settlement offer.

To accept, the business must provide documentation, such as copies of filed Forms 1099 and a written statement explaining the “reasonable basis” for the classification. The settlement is finalized through a closing agreement signed by the taxpayer and the IRS, which states the amount to be paid and confirms the reclassification requirement.