Tax Court Ruling Establishes Oversight of IRS Administrative Settlement Programs

Published: Dec 1, 2022
Topics: Tax
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The IRS offers several administrative settlement programs, which allow taxpayers to voluntarily correct an error or omission, such as worker misclassification (employee vs. independent contractor), failure to disclose offshore accounts, or participation in certain transactions that the IRS deems abusive (i.e., tax shelters). Taxpayers who participate in these programs are able to come into compliance while mitigating their potential exposure. Until now, the IRS had total control over the administration of these settlement programs, without judicial oversight. In a recent ruling,^[1] however, the Tax Court asserted that it has jurisdiction to review determinations made by the IRS related to administrative settlement programs, including determinations about whether a taxpayer is eligible to participate in such a program.

Treece Financial Services

Dock Treece was the sole corporate officer for Treece Financial Services (the “Petitioner”) during tax years 2015 through 2017. Although corporate officers are defined as statutory employees under IRC Sec. 3401(c), Treece was paid as an independent contractor. On October 23, 2018, the Petitioner applied for participation in the IRS’s Voluntary Classification Settlement Program (“VCSP”), a program that allows businesses to reclassify independent contractors as employees on a prospective basis and pay a relatively small one-time penalty.^[2] Businesses that voluntarily reclassify their workers under this program can mitigate the risk of being subjected to a full-blown employment tax examination that could result in huge assessments of tax, penalties, and interest for multiple past years.

One of the eligibility requirements for the VCSP is that the business applies for participation prior to being selected for an employment tax examination by either the IRS or a state agency. On February 28, 2019, the IRS denied the Petitioner’s application, stating: “You’re under an employment tax examination.” The IRS proceeded to conduct the employment tax examination and, on October 10, 2019, issued a determination reclassifying Treece as an employee and assessing tax, penalties, and interest for 2015 through 2017. The Petitioner filed a petition with the U.S. Tax Court to challenge the assessment and the IRS’s determination that it was not eligible for the favorable terms of the VCSP.

The IRS filed a motion to partially dismiss, claiming that the court lacked jurisdiction to review determinations about eligibility for an administrative settlement program. The court disagreed, holding that “there is a strong presumption that an act of administrative discretion is subject to judicial review.” The court has not yet made a ruling on the merits of the case, but only asserted that it has the jurisdiction to determine this issue.

Administrative Settlement Programs

Under the terms of the VCSP, taxpayers who come forward voluntarily and reclassify their workers from independent contractors to employees are only required to pay 10% of the employment taxes that would have been due for the most recent tax year, determined under the reduced rates of IRC Sec. 3509, rather than paying 100% of the employment taxes for up to three years (plus interest and penalties). If a taxpayer has been selected for an employment tax examination, it’s too late to apply for the VCSP, but they may still be eligible for the Classification Settlement Program (“CSP”). While the terms of the CSP are not quite as favorable as the VCSP, they are still much better than what could happen in the event of a normal employment tax examination.

Other examples of administrative settlement programs offered by the IRS include the ongoing 2020 micro-captive insurance resolution program, as well as Streamlined Filing Compliance Procedures for taxpayers who have failed to disclose or report income from foreign assets. Each of these programs has its own eligibility requirements, and each offers taxpayers an opportunity to voluntarily come into compliance in exchange for some measure of leniency.

The Tax Court’s ruling in Treece Financial Services gives taxpayers more leverage in negotiating with the IRS about the application of these programs, as well as offering due process to taxpayers who are denied participation in the programs by the IRS. This will help ensure that the programs are administered equitably.

[1] Treece Financial Services Group v. Comm’r, 158 T.C. No. 6 (2022).

[2] https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program.

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