The Internal Revenue Service in 2010 issued a ruling with regard to the treatment of individuals who were once employees of the company and who subsequently return to work for a past employer as independent contractors. The IRS essentially stated, “once an employee, always an employee.” However, the interpretation of this ruling has varied widely, depending on the institution

If an individual worked for a company and for whatever reason (e.g., layoff, termination, retirement) leaves and then subsequently returns to the company as an “independent contractor,” the IRS has essentially limited the instances and method as to how this can occur. These limitations are motivated by factors including employment taxes as well as possible discrimination against these employees for benefits.

According to the IRS, an individual will remain an “employee” and cannot be classified as an independent contractor if the individual returns and does essentially the same work and acts as an employee (including time of work, location, tools, and oversight provided by the company). The IRS checklist of what constitutes and employee status and what is an independent contractor must be strictly adhered to. Companies need to understand how to apply the “once and always an employee” ruling in order to not fall into a quagmire of tax and employment compliance issues.

For example, if a former employee returns as part of another legal entity, such as a legally incorporated consultant, “once an employee always an employee” doesn’t apply. The individual is now in business for him / herself and is an employee of another entity. However, in the situation in which an individual formerly employed at your business now works for another company, but “moonlights” at your company, the ruling still stands because the individual is still fulfilling the role or specialty that they had at your organization as an employee.

If you hire a past employee through another company to perform work, then “once and always” isn’t applicable. You’ve outsourced to an external company and the past employee is an employee of the new company.

The bottom line is, your bottom line will be significantly impacted if it is found to be noncompliant in classifying employees, contactors and companies performing the work. Fines, penalties and tax bills can result and be significant. So define your relationships well and carefully! Know when an employee will be an employee forever and ever … once and always … and when the employee can transition to a vendor.

© 2010 F.O.C.U.S. Resource Inc. All Rights Reserved

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