Q. “Are there any legal issues with having some of our full-time permanent employees also having contracts to do subcontractor work (1099) for the same place they are employed?" -- S.M., Wisconsin
A. Yes, there are. First, you need to be sure that that employee’s work as an independent contractor is correctly identified as such. An answer I provided last week discussed the criteria for evaluating whether the relationship of an employer to an independent contractor can be properly considered an independent contractor relationship. Very briefly, that inquiry looks at whether the employer has the right under the contract to control the “behavior” of the independent contractor, or loosely stated, how the employee performs the services; who controls the financial aspects of the transaction; and how the parties perceive their relationship. You must therefore examine the facts of the proposed relationship to determine if a true contractor relationship could exist on a case-by-case basis.
When you wish to contract with a current employee, it is important to look at the nature of the work the employee will perform as an “independent contractor.” If the work is similar to that which he or she performs as an employee, it is unlikely that a true independent contractor relationship is formed. In your scenario, it also seems unlikely that a full-time employee (there are no "permanent" employees!) would have a lot of time in which to market his or her independent contractor services to other entities, although that alone would not be a deciding factor.
As an example, consider if an employee worked for you full time in a marketing capacity, but offered to perform interior design services on a contact basis in his or her non-work hours. In this circumstance, an independent contractor relationship sounds plausible. If, however, a technical employee working in software implementation offered to provide software development services on a contract basis, the relationship would at least on the surface appear to be more akin to an employment relationship.
The consequences of getting the decision wrong can be significant. If your full-time employee is non-exempt for purposes of overtime, and his or her work as a “contractor” is found really to have been part of the employment relationship, he or she may have a claim for overtime compensation for combined hours worked in excess of 40 in a work week. This is a very active claim in employment litigation, probably because the penalties can be stiff, and include up to three times the amount of the unpaid wages. You can also run into trouble with authorities on the issues of unemployment insurance contributions and workers compensation coverage. Remember also that the Internal Revenue Service will scrutinize closely tax documents that seem to reflect a concurrent employment and contract relationship.