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How to Convert a Contractor to an Employee: A Step-by-Step Guide

how to convert a contractor to an employee

To convert a contractor to an employee, you must assess the feasibility of the conversion, craft a competitive offer, and ensure compliance. In this article, we dive deep into the process and the questions you must ask before and during the process.

Key Takeaways

  • Reclassifying contractors as employees is often key to growing your business and ensuring compliance
  • Leveraging an EOR can be the simplest way to convert a contractor to an employee if you do not own a subsidiary in the contractor’s jurisdiction. 
  • Ensure the individual fits the company culture and has been fully integrated into your HR and payroll system before you convert a contractor to an employee. 

“Convert contractor to employee” – it’s a very common search phrase, and for good reason! Converting a contractor to an employee can be complex, requiring assessing the feasibility of the conversion, crafting a competitive offer, and ensuring compliance. In this article, we dive deep into the process and the questions you must ask if you want to convert independent contractors (enabling that person to have an employment contract and receive employee benefits) into full compliance with employment laws (even without a local entity!)

We’ll also cover the fundamental differences between a contractor and an employee, why you may or may not wish to convert a contractor to an employee, and how working with an Employer of Record (EOR) can simplify the process, especially for international contractors.

graphic on theme of how to convert a contractor to an employee

5 Steps to Convert a Contractor to an Employee

Step 1
Assess the Feasibility
Know the difference between a contractor and an employee, determine whether reclassification suits your needs
Step 2
Leverage an EOR
If you do not have a legal entity in the contractor’s jurisdiction, an EOR service will simplify the reclassification process. 
Step 2
Create a Competitive Offer
Determine the most competitive benefits package for the position, understand whether the potential new employee prefers remote or hybrid working.
Step 3
Ensure a Compliant Transition
Consult with experts to know the tax and labor laws in the new employee’s jurisdiction. Onboard the new employee onto your payroll and HR management system.
Step 4
Maintaining Compliance
Provide the required benefits, stay up to changes in local laws and regulations, report regularly.

detailed infographic showing how to convert a contractor to an employee

Step 1: Assessing the feasibility

Independent contractors and full-time employees have distinct legal definitions and roles within a company. These are important to know if you want to convert a contractor to an employee. Independent contractors are self-employed and provide services at an agreed rate. They have the flexibility to work on their own schedule. They often work for multiple clients and are responsible for their own taxes. On the other hand, full-time employees are employed by a company on a permanent basis, with a fixed schedule, and receive compensation in the form of salary and benefits.

  • The determination of whether a worker is a contractor or an employee is based on various factors related to the financial and behavioral relationships between the employer and the worker.
  • Understanding these differences is key as misclassifications can result in significant penalties and harm a company’s reputation.

What is the difference between a contractor and an employee?

The precise legal definition of a contractor and an employee will depend on the contractor’s jurisdiction; you should acquaint yourself with the laws and regulations in the contractor’s country or state to ensure that they are not misclassified already. In general, the differences between a contractor an employee are as follows:

DifferenceContractorsEmployees
1May have other clients
Works exclusively for the company
2Most equipment provided by the contractor
Most equipment provided by the company
3Responsible for their own taxes
Company responsible for tax reporting
4No benefits
Statutory and customary benefits
5Sets their own working hoursFixed schedule
6Paid per job
Paid hourly or on salary

Why convert a contractor to an employee?

Converting from contractor to full-time employee comes with benefits. You will have your own needs, particular to your business goals and the work of the potential new employee. If you are unsure of whether the reclassification is necessary, consider the benefits of converting a contractor to an employee below:

Avoid MisclassificationIf a contractor is found to be working as an employee, this can lead to fines or worse for the business. These classifications vary by jurisdiction; a contractor relationship may be compliant in one country, but the same work may not be compliant in another.
Safeguard Intellectual PropertyFull-time employees typically sign agreements that ensure a company’s intellectual property rights are preserved, whereas contractors may be less inclined to do so. Transitioning contractors to employees allows companies to safeguard their valuable assets and uphold a competitive edge in the market.
Achieve Long-term ObjectivesOften, contractors are hired to help kick-start a new product or service, or open a new market. As the new business unit grows, it can be beneficial to have the original team stay on as full-time employees.
Maintaining Top TalentIn today’s competitive business environment, retaining skilled workers is essential for a company’s long-term success and growth. By offering employee benefits, such as health insurance, paid time off, and retirement savings, companies can incentivize contractors to accept full-time employment.

Does conversion serve the needs of the business?

Ensure that the contractor-to-employee conversation will serve your financial needs, business development goals, the need for compliance, and that it will work with your company culture.

Financial needs

To determine whether it is financially logical to transition a contractor to an employee:

  • Calculate the contractor’s hourly rate and multiply it by 2,080 hours. This is the standard number of hours a full-time employee typically works in a year.
  • Add the estimated cost of benefits, paid leave, additional taxes, equipment, and other costs particular to your organization.
  • If you are using an EOR, add the costs of the EOR service.

Business development needs

Ask yourself and your management whether the company will be needing a full-time employee with the contractor’s specific skillset as you move forward. Is any part of their new job description already covered by other employees? Do they have other skills or potentials that are being untapped as a contractor, but will benefit the organization as a full-time employee?

Compliance needs

If the contractor is located in another country, you will need to know how to compliantly hire the new employee. Find out the compliance needs and ensure that you can meet them. Compliant international hiring is most often done through an owned subsidiary or a Global EOR.

Company culture

Will the contractor fit with your company culture and existing teams? If they are your only remote employee, or if they will become your first full-time employee, this could affect your workflow and their relationship with other team members.

Step 2: Leveraging an EOR 

 If you already own a subsidiary in the contractor’s jurisdiction, you may not require an EOR. If you do not, and the contractor resides and works in another country, an EOR will most likely be the simplest solution. Anyone looking to convert a contractor to an employee should in any case consider an EOR because of the simplicity of the conversion with professional help.
 

What is an EOR?

  • An EOR is an “Employer of Record”. They hire through their legal entities and are liable for all tax reporting and other compliance issues. 
  • As the client, you are responsible for managing the employee, assigning tasks, and reviewing performance. All intellectual property and the right to hire and offboard employees are retained by the client. 
  • Global EORs enable hiring in most countries around the world; many also support contractor payments and converting contractors to employees. 
  • Employer of record (EOR) solutions can streamline the onboarding process, provide businesses with the necessary tools to manage remote employees and ensure compliance with local labor laws and regulations. Additionally, these platforms may assist in equipment purchases, further easing the transition.

Companies like Horizons, Velocity Global, Multiplier, and Deel offer comprehensive solutions for hiring full-time employees and independent contractors, as well as a straightforward process for switching between the two if you want to convert a contractor to an employee. These platforms can save businesses time and resources while ensuring a smooth and compliant transition.

Utilizing technology and services allows companies to concentrate on their core business objectives and growth, efficiently manage their workforce and guarantee a smooth transition from contractor to employee.

In considering whether to use an EOR to convert a contractor to an employee, ask yourself:

  • Do you have the internal capabilities required to compliantly hire the new employee? For international jurisdictions, browse our country guides to acquaint yourself with the compliance environment.
  • What are the costs of compliantly hiring the contractor on your own and are they greater than the costs of using an EOR?
  • Which EOR will best serve your particular needs?

Step 3: Creating a competitive offer

To incentivize contractors to accept full-time employment, companies must craft a competitive offer that includes not only a fair salary but also a comprehensive benefits package. This could include:

  • Health insurance at a reduced cost
  • Retirement contributions
  • Life insurance protection
  • Paid vacation days

Providing competitive employee benefits is key to drawing and retaining skilled employees, thereby ensuring team motivation, productivity, and overall well-being. In addition to salary and benefits, companies can also offer flexible working arrangements, such as remote working, unlimited paid time off, and adjustable working hours.

Step 4: Ensuring a compliant transition

Employers should consult with legal counsel or human resources professionals to verify worker classification and gather necessary documents to comply with local laws and regulations.

Converting contractors to employees can become more complex when dealing with international employment. In such cases, companies must navigate the tax and labor laws of the foreign country where the contractor lives and works. This requires a thorough understanding of local employment regulations and the provision of benefits according to local standards. Therefore, companies must conduct thorough research and, if necessary, seek legal counsel to ensure compliance with the laws of the country in which the contractor is based.

Adjusting company payroll is another crucial step in the conversion process. Employers must configure the appropriate withholdings and contributions for the new employee using their employee’s withholding certificate. Once the employee is added to the payroll, the human resources department should enroll them in any applicable benefit programs based on their entitlements.

Lastly, onboarding the new employee involves:

  • Ensuring they virtually meet the rest of the team
  • Providing them with the necessary resources
  • Pairing them with a senior team member who can facilitate their acclimation

Step 5: Maintaining Compliance

Maintaining compliance after the transition of a contractor into an employee is vital for effective personnel management and adherence to local labor laws and regulations. This involves:

  • Using accurate tax forms
  • Calculating appropriate payroll taxes and contributions
  • Providing statutory benefits
  • Adhering to fair labor standards in each country where employees are based.

Keeping precise records and documentation of the conversion process is crucial for potential audits or resolving any future discrepancies. Companies should also stay up-to-date with any changes in local laws and regulations to avoid potential penalties and ensure ongoing compliance.

By prioritizing compliance after conversion, companies can avoid potential legal issues, maintain a happy and productive workforce, and focus on their growth and success.

What Does it Cost to Convert a Contractor to an Employee?

When your business grows and your relationship with a contractor deepens, it makes sense to consider how to convert a contractor to an employee. But how much does this process cost? The answer depends on the method you use to make the switch.

Understanding Why Contractors Cost More

Before looking at specific conversion costs, any business that wants to convert a contractor to an employee should understand why contractors typically charge higher hourly rates than employees.

  • Self-Employment Taxes: In the US, for example, contractors must pay both the employer and employee portions of Social Security and Medicare taxes (totaling 15.3%). Employees only pay half.
  • Benefits: Contractors don’t receive benefits like health insurance, retirement plans, or paid time off, so they factor these costs into their rates.
  • Lack of Security: Contractors often charge a premium as they aren’t guaranteed regular, long-term work.

Methods for Converting Contractors to Employees (and Their Costs)

Let’s break down three common methods and their associated costs:

1. Do-It-Yourself (DIY)

  • Cost: Initially the cheapest, but can get expensive if you make mistakes.
  • Process: Calculate an equivalent salary considering benefits; handle new hire paperwork and tax setup; update payroll systems; and potentially face legal risks if you misclassify the worker.

2. Employment Lawyer

  • Cost: Expect hourly legal fees ranging from $150-$500+ per hour.
  • Process: Lawyer helps with determining an appropriate salary; lawyer drafts an employment contract; and, ;awyer ensures legal compliance and avoids misclassification issues.

3. Employer of Record (EOR)

  • Cost: EORs typically charge a percentage of the employee’s salary or a flat monthly fee.
  • Process: EOR handles all legal, payroll, tax, and benefits administration; EOR assumes liability, ensuring compliance; and, an EOR is often the most streamlined solution, especially for international conversions.

Additional Considerations

The cost of converting a contractor to an employee involves more than just a new salary. Other factors that impact costs for businesses wanting to convert a contractor to an employee include:

  • Benefits: Factor in the cost of health insurance, retirement contributions, and other benefits.
  • Taxes: Employer-side payroll taxes add an extra percentage to the employee’s salary.
  • Equipment and Workspace: You may need to provide a computer, desk, or other work tools.

Choosing the right option when considering how to convert a contractor to an employee is crucial. Weigh the costs, risks, and your own internal resources before making a decision.

Summary

In considering how to convert a contractor to an employee, businesses have a lot of issues to think about. As the business landscape continues to evolve, the ability to adapt and make informed decisions about workforce management will remain crucial for companies striving to achieve their goals and maintain a competitive edge in the market.

Understanding the differences between contractors and employees, determining which classification is the most compliant and beneficial to your business, and ensuring compliance is essential to fast and flexible business growth.

FAQ

To reclassify an independent contractor to an employee, you need to determine payments, develop a new compensation package, consider a release, develop a communication plan, and meet with the worker to discuss the change in status.

Converting contractors to employees gives them access to paid time off, unemployment protections, healthcare options, and retirement savings opportunities. It also provides an opportunity to build loyalty and develop their skills in a supportive team environment.

 

A contractor conversion is when a contract worker is hired on full-time after demonstrating their value to the company through a period of working in a contracted role. This is also referred to as temp-to-hire or contract-to-permanent conversion.

To convert contractor rate to salary, take the contractor's hourly rate and multiply it by 2,080 hours, which is the total number of hours a full-time employee generally works annually. However, bear in mind that independent contractors' rates usually reflect the extra expenses and taxes they must pay as self-employed people.

Independent contractors are self-employed and offer work services on an autonomous schedule, whereas full-time employees are employed by a company on a permanent basis with a fixed schedule and benefits.Using an Employer of Record for Contractor to Employee Conversion

An Employer of Record (EOR) can be a valuable partner when converting contractors to employees, particularly in international contexts. Here's how you can use an EOR to facilitate this conversion:

  1. Compliance with Local Laws: An EOR has expertise in local employment laws and regulations, which helps ensure compliance during the conversion process. They can handle legal paperwork and ensure that all employment practices adhere to local standards.

  2. Payroll and Benefits Administration: EORs manage payroll and administer benefits on behalf of the company. This includes calculating and withholding appropriate taxes, providing statutory benefits, and ensuring accurate and timely payment to employees.

  3. Risk Management: By acting as the legal employer, the EOR assumes many of the risks associated with employment, such as compliance with labor laws and regulations. This can protect your company from potential legal issues that could arise during the conversion process.

  4. Streamlined Process: An EOR can streamline the conversion process by providing a single point of contact for all employment-related matters. This can save time and resources, allowing your company to focus on its core business activities.

Remember, while an EOR can significantly simplify the conversion process, it's important to maintain clear communication with your contractors about the changes and what they can expect as they transition to full-time employees.

The process of transitioning contractors to employees involves a careful evaluation of worker classification, legal obligations, and compliance requirements. It typically includes a thorough review of employment agreements, tax implications, benefits considerations, and the establishment of new employment contracts. Consulting with legal and HR professionals is crucial to ensure a smooth and compliant transition.

Converting contractors to employees offers several advantages for businesses. By transitioning contractors to employees, companies can establish stronger control and direction over work processes, foster a greater sense of loyalty and commitment, and enhance team integration. Additionally, employees typically receive benefits such as healthcare coverage, retirement plans, and paid time off, which can contribute to higher job satisfaction and retention rates.

Transitioning contractors to employees involves considering various legal implications. It is crucial to assess worker classification, ensuring compliance with labor laws, tax regulations, and employee benefits requirements. Misclassifying workers can lead to significant legal consequences and penalties. Seeking legal counsel and thoroughly understanding the applicable laws and regulations within your jurisdiction is essential to avoid potential legal issues.

Reece is RemotePad’s finance and accounting specialist. Reece is the go-to contributor when RemotePad advises on the financial implications of remote work and hiring employees, locally and internationally. Based in the southern New Zealand city of Dunedin, Reece has a Bachelor of Commerce degree, majoring in Accounting, from the University of Otago.

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