Converting From a Contractor to an Employee

Hiring contractors can be a viable solution for project-based work that requires highly specialised skills. However, at a certain point, it might become more economically sound and less risky to convert contractors to employees. 

If you want to know the differences between contractors and employees, the benefits, and the whole process of converting from a contractor to an employee, this blog will get you started. 

Contractor vs. employee: What’s the difference?

The two worker classifications — contractors and employees perform the same work duties, participate in meetings, and collaborate with the same team. That said, there are important aspects associated with benefits, pay, and exclusivity which highlight the differences between these two workers. 

Benefits

A purely contractual relationship doesn’t entail benefits such as healthcare, sick care, paid time off, and parental leave. 

Independent contractors receive pay per project and use these financial gains to cover the expenses that come with benefits on their own. On the other hand, employees are entitled to statuary benefits based on the employment laws in their jurisdiction. 

Taxes

Contractual workers submit invoices to receive payment for their work and are obliged to handle their tax contributions. 

Most countries have a strict end-of-the-year policy that requires all workers, including contractors, to declare and pay tax on earnings. Full-time employees have their taxes dedicated and paid by their employer with every received salary. 

Exclusivity

Thanks to the rise of the gig economy, contractors have the opportunity to work with multiple clients and projects. 

Contractors typically have diverse set of skill sets, which allows them to benefit financially from engaging in different projects at a time. However, the trend of juggling multiple jobs is not as common in the full-time employees’ sphere, although it’s technically possible. 

Salary vs. contractor rate

One of the key differences between contractors vs employees is the method and process of payment. For instance, a contractor will submit an invoice on a daily or monthly basis based on the previously agreed rate per hour and work produced. 

During an employment relationship, full-time employees avoid the hassle of sending requests for payments or invoices. Their salary is usually administrated once a month with obligatory withholdings made on the employee’s behalf. 

What are the advantages for the employer?

For businesses that want to make their presence on the global market stage, hiring contractors is a common approach. 

Utilising the expertise of contractors instead of employees can also come with risks and costs. To mitigate potential obstacles, employers should consider converting their contractors to employees. Here are some benefits businesses can harness with a team of full-time employees. 

• Protect intellectual property. Contractors obtain thorough insight into the business’s operations, making them a valuable asset to competitors. By turning contractors into employees, businesses will strengthen their security policies regarding their intellectual property. 
• Retain top talent. Experienced contractors can bring businesses significant results and help to achieve objectives in the long run. Moreover, turning contractors into employees streamlines the onboarding and training process, as they will already be acquainted with the workflow. 
• Reduce the risk of compliance. The lines between contractors and employees can become blurred, making the business vulnerable to labour and tax violations. With the transition to employees, such misclassifications can be sidestepped. 
• Control work schedules. According to most labour laws, contractors have the freedom to choose their rhythm of work and don’t have to adhere to the traditional work schedule. For businesses that want to maintain control over their team schedule, having full-time employees is a great way to establish supervision. 

What are the advantages for the worker?

Working as a contractor offers the flexibility of working on one’s own terms. However, there’s the drawback of not having benefits or job security.

This section will outline some of the advantages for contractors as they transition from a contractual agreement into an employment relationship. 

• Provides access to benefits. Employees are entitled to a plethora of benefits, like health insurance, social security, vacation, and parental leave, which contractors don’t receive. Having access to these benefits can lead to an increase in productivity and satisfied employees. 
• Supports the worker’s career goals. For some independent contractors, converting to full-time employees can help them to realise their career goals. Working in an established company allows them to play a major role and climb their way up the business ladder.
• Handled tax management. Employers typically take on the taxation responsibility for the employee. When the contractor signs the employment contract, they will no longer carry the burden of complying with local tax laws. 

When should you convert a contractor to an employee?

Businesses that have misclassified an employee as an independent contractor will have to perform the conversion promptly. In that way, they will avoid any legal repercussions. In addition, if the contractor has proven capable of supporting the growth of the business, then they will be the perfect fit for a talent gap on a permanent basis. 

Another sign is when a long-term relationship beyond the usual contractor agreement develops. In such cases, offering an employment package and more long-term work will strengthen their position and presence at a company. 

Why convert contractors into employees?

There are numerous reasons why transitioning contractors into employees is a pragmatic move. It’s important to note that the whole process depends on several factors, such as legal considerations and the nature of work. 

Here are a few reasons why businesses should consider converting contractors into employees. 

Addressing a business need

Finding and onboarding the right talent can be a hefty task. Opening positions to the global talent pool expands options, but it’s quite time-consuming. 

If the contractor’s skills and experience are aligned with a certain business need, the transitioning process will become more straightforward. An established relationship and having a firm grasp of the company’s environment and culture can ease the transition to an employee. 

Avoid losing contractors to competitors

Some businesses prefer their contractors to serve the purposes of their organisation solely. Non-compete agreements are a possible solution; however, they aren’t effective in all jurisdictions. 

To prevent the high-performing contractor from working with competitors, businesses should hire them as employees. Non-compete agreements are also available for employees so they can be included in the independent contractor’s employment contract. 

Optimise costs in the long run 

Businesses aren’t legally obliged to pay any benefits to contractors, but they are still not the most cost-effective labour choice. In fact, hiring contractors may be the more high-cost option because they charge higher rates per hour. 

The longer a business works with contractors, the more money they spend that could have been directed toward internal talent. When converting a contractor to an employee, the worker immediately becomes a more productive long-term asset. 

What are the risks of working with independent contractors?

Many businesses assume that working with independent contractors is a cost-effective and hassle-free option. However, contracting can come with non-compliance penalties to complications with permanent establishment risk. 

Here are some of the risks and pitfalls businesses should ponder when working with independent contractors. 

Misclassification

One of the biggest risks that contractual engagement poses is worker misclassification. Complications arise due to the lack of standardised criteria across countries on worker classification. 

Failing to label and classify a contractor properly could result in businesses having to pay back-taxes with interest, large fines, and even facing lawsuits. Employing compliantly with local laws and regulations eliminates the misclassification risk and the potential financial costs. 

Permanent establishment risk 

Hiring independent contractors can trigger permanent establishment risk, making the business legally responsible for paying corporate taxes in multiple jurisdictions. 

Hiring full-time employees is a strategic and more secure way to avoid the permanent establishment risk. While businesses might still be liable to pay corporate tax, hiring permanent staff is considered legal and transparent by the local authorities. 

More liability 

When employing contractors, businesses are opening themselves to a new host of liabilities that could be easily prevented by hiring full-time employees. 

This could include injuries sustained at the workplace, being sued for wrongful acts, or unemployment compensation claims. In addition, if the independent contractor takes legal action for misclassification, businesses could find themselves in expensive waters. 

Lack of loyalty

Loyal employees create loyal customers and, in turn, create satisfied shareholders. Therefore, loyal employees are an invaluable asset to any business. 

Full-time employees have the chance to be a part of the company’s growth. Contractors only stay for a specified amount of time as their contract dictates. Employers can’t expect loyalty and dedication from their contractors or to go beyond what their contract specifies. 

How to proceed to convert independent contractors to employees?

Making the step to convert independent contractors into employees is more than just an agreement between two parties. It necessitates legal manoeuvring and other essential steps followed through accurately. 

The whole process is narrowed down to a few steps in the section below. 

1. Calculate the hiring expenses

Before transitioning a contractor to an employee, it’s vital to establish if the process is financially viable for the business. 

By calculating the additional expenses related to hiring employees, businesses will get a more realistic idea of the total cost. The training costs, salary figures, equipment investments, benefits, and payroll taxes should all be taken into account when making calculations. 

2. Check legal viability

Once the financial aspect is established, businesses need to determine if the contractor can become an employee legally. 

If the individual contractor lives in a different country, the businesses will need to open a legal entity. If the business doesn’t own a legal entity in the country where the contractor is located, it can use the EOR services, which will hire employees on the business’s behalf. 

3. Sign an employment contract

If the contractor has agreed to the full-time employee arrangement, the next step would be to create an employment contract. 

It should outline the job responsibilities, working hours, benefits, employment period, termination notice, and confidentiality. For international employees, the contract must be in alignment with the local labour law requirements. 

4. Add the new employee to the company payroll

Paying a contractor’s invoice differs greatly from paying a salary as it includes tax deductions and withholdings. 

Employee data should be added to the payroll software. Handling currency conversions, exchange rates, and bank transfer fees for multinational employees requires setting up an international payroll. 

Wrapping up

Converting from a contractor to an employee aids businesses in avoiding misclassification risks. Plus, it allows them to retain top talent and use their expertise to produce quality output. Finally, they need to ensure the appropriate compensation package to get the contractor on board.