When you have a small business, it’s fairly straightforward converting a contractor to a full-time employee, but this same process for enterprises takes more time, resources, and due diligence.

So why convert contractors into full-time employees? When enterprises hire contractors, there’s a higher chance of misclassification, which results in heavy fines and penalties.

Enterprises may also prefer employees over contractors, because unlike full-time employees, contractors can move from one client to the next, using their resources for several clients at a time. Full-time employees can put all of their energy into company projects, contribute to your business’ morale, and help the business make more money in the long run.

When converting a contractor to an employee, one of the first things enterprises need to address is salary and what the difference will come out to for the workers.

International contractor rate vs a full-time employee salary

Contractors typically earn a higher wage than employees because businesses do not need to pay for benefits, but there are other financial gaps as well. In the chart below, we compare the figures of a contractor and a full-time employee:

DifferenceContractorEmployee
Payment StructurePer hour or per project. Contractors invoice clients for work performed, and payment is based on the agreed-upon terms outlined in the contract.Employees receive weekly, bi-weekly, or monthly payments. The salary is predetermined and often based on an annual or hourly rate.
Tax ObligationsContractors are considered self-employed and pay their own taxes. Contractors can receive deductions for business expenses.Employers must withhold federal income tax from employees’ wages. In the U.S., employers withhold federal, state, and local taxes and Social Security and Medicare. Employees receive a W-2 form at year’s end, summarizing earnings and tax withholdings.
Benefits and ProtectionsEmployers aren’t obligated to provide contractors with health insurance, retirement plans, PTO, or unemployment benefits. Contractors pay for their insurance coverage and manage their retirement savings.Employers need to know which benefits to offer in the countries employees work from. Employees are protected by employment laws and regulations that mandate fair treatment, nondiscrimination, and minimum wage standards.
Job SecurityContractors are not protected by employment laws in terms of discrimination or wrongful termination, but all employers must be compliant with local laws that protect employees.Varies per country, but employees may have some sort of protection or job security.

Changing a contractor to an employee means providing a full-time salary, benefits, and fulfilling tax obligations. Before making the actual calculations, it’s smart to review company goals, policies, what you’re willing to offer the contractor in terms of salary, and more.

How to convert a contractor’s salary into an employee’s salary

The contractor’s rate vs. your salary capabilities requires you to review your company goals, expectations, and process. Here’s how to get started:

  1. Assess motivation and goals: Understand why you and the contractor would like to make the switch. Is it because of job security, benefits, professional growth, or a mix of factors?
  2. Research company policies: Review your company’s compensation, benefits, and expectations and negotiate accordingly.
  3. Review employee classification rules: Follow the IRS’s guidelines for determining a full-time employee from a contractor, to avoid employee misclassification.
  4. Initiate conversation with the contractor: Request a meeting to express your reasons for the transition, articulating benefits for both you and the contractor.
  5. Negotiate their new salary: Beyond salary, factor in things like payroll taxes, benefits, and insurance that have financial value.
  6. Review employment contract: Have the contractor review the contract, especially salary details, benefits, working hours, and any legal agreements.
  7. Collect their employee information: For tax purposes, give the employee a W-4 and make sure you both complete the 1-9 form. Record their new payment information (salary, rate of pay, exempt or non-exempt status, and so on.
  8. Convert their wages: Convert their hourly wage to annual salary and add the new employee to your payroll.
  9. Help them Transition: For a smooth transition, train them on internal systems, help them build relations with new colleagues, and seamlessly integrate them into their new role.

Before calculating the salary of a contractor vs. full-time salary and embarking on salary negotiations, you’ll likely need to review your company’s benefits and any country requirements.

Benefits offered to a contractor after converting to an employee

Though benefits can vary from enterprise to enterprise, all your employees should receive the same perks. As you convert your contractor into a full-time employee, it’s a good opportunity to revisit which benefits you’ll need to provide based on your country’s laws.

For instance, companies in the U.S. must provide employees with:

For enterprises outside of the U.S. you can refer to Papaya’s countrypedia for a full list of countries and their required benefits.

After clarifying which benefits you’re already providing and reviewing which are legally required, you can start preparing for salary negotiations.

Contractor to full-time employee salary negotiation

Come prepared to the negotiating table with research on payroll compliance. Dive into what you’re able to afford and provide the new employee, whether your offering is competitive with similar roles within your industry, the expected value they’ll bring, and so on.

  1. Budget Constraints: Consider your budget constraints when negotiating salary with a contractor transitioning to a full-time employee. They may not earn as high a figure as before, but they’ll have additional benefits.
  2. Total Compensation: Beyond just salary, factor in the cost of benefits, taxes, and other employee-related expenses.
  3. Market Rates: Review the market rates for similar positions to ensure competitive and fair salary offerings.
  4. Value to Company: Assessing the contractor’s value, experience, and skills in relation to the new role can guide the negotiation.
  5. Legal and Compliance Aspects: Ensure that the negotiated terms comply with legal and regulatory requirements to avoid any compliance issues.

The last step of the negotiation process is ensuring you have all your legal bases covered. Aside from factoring in taxes you’ll withhold, you will also need to shift your relationship with the worker and fulfill certain labor requirements.

There’s a reason many smart businesses prioritize compliance; heavy fines, reputational damage, and a potential loss of operations would harm any company’s bottom line.

If you’re operating in the U.S., you can use the ABC test to correctly classify workers. Under the ABC test, a worker is an employee unless the following is true:

  1. Is the worker free from the company’s control via contract/agreement and in practice? Employers and contractors must prove the contractor has control over how they perform their duties, such as when, how, and where they complete the work.
  2. Is the service performed outside the usual business for the worker? If the worker’s duties are significantly different from what the company does, they’re likely considered a contractor.
  3. Does the worker have an independently established trade, profession, or business that matches their services? If the worker can prove an established business that’s in line with their provided services and that their business entity was formed before the work was completed, they can be classified as an independent contractor.

While there are several important factors to consider when converting a contractor into an employee, there’s one fool-proof way to ensure a seamless transition and compliance.

Instantly carry out smart decisions for your enterprise with Papaya

In some instances, running enterprise operations doesn’t leave much time for crucial details such as worker compliance. Let Papaya Global handle the nuts and bolts of converting contractors to workers, while you focus on the bigger picture.

Papaya Global’s team of experts specializes in compliance, benefits, payroll, and more to ensure you’re always above board. See why companies trust Papaya’s end-to-end platform to support growing workforces every step of the way. Try a demo today.

FAQs

How much more should a contractor make than an employee?

A contractor’s rate depends on their experience level, the contractor agreement between the company and the contractor, and the scope of the project. In many instances, contractors request a higher rate than full-time employees because employers are not withholding taxes and providing benefits. As a general rule, expect to pay contractors between 50% to 70% more than what you would pay a permanent employee. Employers often pay contractors more because they’re not required to enter into full-time, long-term contracts with them.

How do contract workers get paid?

Depending on the contractor agreement, contractors can get paid per hour, by the project, or in installments. Payment is agreed upon by the employer and contractor up front. To receive payment, contractors must fulfill their side of the agreement. In addition, contractors must send an invoice to the client (the company) to receive payment.

How do you calculate the 1099 hourly rate?

To determine the rate to pay contractors by the hour, you’ll need to use a specific formula. Employers can first research the average salary for a full-time worker in the same profession as the contractor for an idea of what the contractor may charge. Once the contractor sends their financial requirements, you can calculate the hourly rate:

Annual salary of a full time employee with similar job duties / (40 hours per week x 52 weeks) = contractor hourly rate

 

Can an employee also be an independent contractor?

According to the IRS, it is possible to have a W-2 employee who also performs work as a 1099 independent contractor. In this instance, the individual must perform completely different duties that fall under the independent contractor classification guidelines. While it is possible to be an employee and an independent contractor for one company at the same time, many businesses choose to avoid this because it opens them up to IRS inquiry. If companies aren’t fully compliant, they will face consequences such as financial or legal penalties.

How long can a contractor work for the same company?

There is no time limit for how long a contractor can work for the same company. As the relationship continues, businesses may want to take extra precaution not to treat the contractor as an employee. Treating the contractor as an employee would change the worker’s status and put the business at risk for non-compliance. Following the ABC test can help employers understand whether they are still treating the worker as a contractor.