Question of the Month - March 2010

Can We Ask an Executive Who Has Been Laid Off to Continue Working as a Part-time Consultant?
This arrangement can work if properly structured and if the actual circumstances meet the requirements of the law.

In the current economy, some employers have found that they need to trim their workforce while retaining the services of knowledgeable executives. The parties often look to the concept of the "business consultant" as the model for their arrangement. This would involve entering into an agreement with the individual that their employment would end, but that they would continue to perform the same or similar services on a part-time basis, but with no insurance, no paid time off, or other benefits. Payments to the consultant would not be subject to the usual withholding and would be documented through a 1099 form as "miscellaneous income" rather than a W-2 form. But many employers do not realize that the company and the consultant cannot just agree to this arrangement.

The consultant must be an independent contractor meeting the standards for that classification under federal and state law. There are federal and state tests for determining whether a paid worker can be properly classified as an independent contractor. These tests examine how much control is exercised over the worker to determine if the worker is truly "independent." Colorado's unemployment statute provides an example of the types of issues that are examined. To be an independent consultant the individual must be "free from control and direction in the performance of the work," and "engaged in an independent trade, occupation, profession or business related to the service performed." In other words, the consultant must exercise a great deal of freedom in how, when, and where the work will be done. It would not be appropriate, for instance to set the consultant's work hours or provide detailed instructions on how tasks must be accomplished. Deadlines are appropriate, but should relate to completion of projects rather than accomplishment of specific tasks. Evaluation systems must focus on the quality of the end product and not measure specific details of the work performed.

Consultants should furnish their own means to accomplish their work and cover their own expenses. If the company provides the consultant with an office, supplies, telephones and other equipment, pays all expenses, and otherwise provides the executive with everything needed to do the job, the consultant looks like an employee and not an independent contractor.

The consultant must have an independent trade or business. This means that your consultant has other businesses for which they consult, and this can be met in two basic ways. The consultants can have several businesses for which they consult simultaneously, or they can work on short term projects for a series of clients, one after another. The key is the consultant does not work for only one organization for an extensive period of time.

The concept of independent contractor has been the subject of legislative and regulatory attention recently. Colorado adopted legislation last year to "crack down" and impose significant unemployment tax penalties on employers for "misclassifying" employees as independent contractors. The agency may assess a penalty of up to $5,000 for the first willful violation of the law, and up to $25,000 for the second and subsequent violations. Many organizations are reviewing their arrangements with individuals who have been working as independent contractors, "contract employees," and "consultants" in view of the new scrutiny.

The company and the consultant should enter into a written agreement setting forth the terms of their arrangement. Under some laws, a well-drafted agreement creates a presumption that the relationship is that of independent contractor and not employment. MSEC has guidance on our website. See our FYI: Independent Contractors - Overview and Sample Agreement for more information.