It has become fairly common to take an outgoing employee and rebrand the employee as a consultant / independent contractor — either as part of a severance plan or to phase the employee into a retirement status.
Be cautious about rebranding any employee as an independent contractor.
First, issuing a W-2 and a 1099 to the same person is likely to raise a red flag with the IRS or DOL in an audit — especially if both reporting forms are issued in the same calendar year. The practice also invites further scrutiny of your overall use of non-employee labor — something every company should want to avoid.
Second, if an individual was properly classified as an employee, then it can be difficult to prove that the same person was later properly classified as a contractor. At the very least, it puts you on the defensive. The fact that the person’s duties may have changed makes little difference, even if the new duties are to stay home and watch reruns of Impractical Jokers.
Remember, the IRS treats severance payments as employment wages, for which deductions and withholdings are required. If pay during employment is treated as wages and pay after employment is treated as wages, it may lead to the conclusion that transition pay should be treated as wages too.
Summary: Be cautious about converting someone from employee to consultant, or employee to contractor. The newly anointed contractor may be misclassified, and the conversion may create a liability for the company.