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Bad News for California Participants in the Federal (IRS) Voluntary Classification Settlement Program

Table of Contents

    Date: 11/20/11

    Topic: Taxation

    This positing is a follow up to my blog posting on 9/21/11 about the new IRS Voluntary Classification Settlement Program. Under this program if a taxpayer has misclassified a worker as an independent contractor (IC) when the worker in reality should have been classified as an employee the taxpayer for federal purposes can reclassify the IC as an employee on a go forward basis with specified minimal negative employment tax ramifications.

    The logical question then becomes what would the state of California do if a California business participated in the IRS program. In California the agency responsible for proper employee classification is the Employment Development Department (EDD).

    Jim Counts CPA CTFA out of Hemet CA is the EDD Liaison to the EDD for the Cal State Society of CPA’s Committee on Taxation and recently asked the EDD about what they will do if a business with a California worker was to participate in the IRS program.

    Jim’s questions and the EDD’s complete responses are below.


    1. What will the EDD do regarding a business that participates in the IRS Voluntary Classification Settlement Program?

    2. Will the EDD accept EDD returns filed with the EDD when the business files under the IRS program? Or will they audit those businesses or what?

    3. If the EDD was to allow no prior period reclassification then when would the EDD consider business under audit? When the worker applied for UI benefits (the business knowing EDD will audit the business) or not until EDD sends an actual notice wanting to audit?


    The Employment Development Department (EDD) welcomes voluntary compliance and does not automatically target those employers who attempt to voluntarily comply with the employment tax laws of California. At this time the EDD is not coordinating efforts with the IRS’s Voluntary Classification Settlement Program (VCSP). However, the employer is still subject to being selected for an audit under the currently established EDD audit selection criteria. (An employer is considered under audit when the employer is notified that the business has been selected by EDD for an employment tax audit.)

    If an employer is selected for an audit, the EDD will follow the current audit guidelines and apply the laws under the California Unemployment Insurance Code (CUIC) on a consistent and uniform basis. The EDD currently does not have the legal authority to allow “no prior period reclassification.” If an employer does not correct prior periods to report the voluntarily reclassified workers to EDD and the employer is subsequently selected for an EDD audit, the employer will be assessed for any unreported and unpaid payroll taxes, plus any applicable penalties and interest. The fact that an employer enters into the IRS VCSP does not exempt them from being audited by EDD and does not provide any employment tax immunity under the CUIC with respect to the voluntarily reclassified workers for prior years.

    The EDD recommends that employers voluntarily report the reclassified workers for the past period and pay the corresponding payroll taxes, which include Unemployment Insurance, Employment Training Tax, State Disability Insurance, and Personal Income Tax, plus penalty and interest. Employers may make a written request for a penalty waiver and explain the reasons why they did not previously report. The EDD will evaluate the facts of each individual penalty waiver request.

    If an employer who participates in the IRS VCSP currently has an employer account number with the EDD, the employer can voluntarily amend their past reports/returns to include the reclassified employees’ wages and pay the amounts due. The employer should continue to include the reclassified employees’ wages on reports/returns filed prospectively with EDD. The EDD will follow the standard procedures to process these reports/returns and payments.

    If an employer who participates in the IRS VCSP does not have an employer account number with EDD, they will be required to register in order to obtain one. Once they receive their account number they can file all the required reports/returns and make the appropriate payments. The EDD will follow the standard procedures to process all the reports/returns and payments.


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