- Differentiating between contractors and employees involves understanding legal distinctions related to taxation, benefits, control, labor laws, and liability.
- Classifying workers should focus on the nature of work they do, not their location, with misclassification posing significant compliance risks.
- Converting a contractor to an employee can offer advantages like increased loyalty, better control, alignment with long-term business goals, and compliance assurance.
Working with contractors has its perks. In many cases, companies may choose to engage with a freelancer or a foreign contractor to get access to niche, skilled expertise without the need to pay social security, employee taxes, healthcare and other benefits.
However, if you’re looking to take on a contractor on a more permanent basis, either because you love their work and contribution to the company, or because you’ve realized you may have been misclassifying them in the first place, then here’s what you need to know:
The legal differences between contractors and employees
First off, it’s important to understand the differences between the two worker classifications from a legal standpoint. These boil down to the following:
Hiring full-time employees means you’re in charge of withholding taxes from paychecks, whether it’s to do with Medicare, income tax, or social security, whereas in the case of contractors, taxation is up to the worker to take care of.
Hired employees are entitled to benefits like healthcare and pension plans. Contractors aren’t.
When contractors are hired, they’re usually in control of their own schedule and how they go about working. They are also able to work with more than one client at a time if they wish. In the case of employees, employers have more control in establishing work schedule. They’re also able to draw up a contract that can stop them from working with other employers.
Full-time and part-time employees are protected by specific labor laws, concerning things like minimum wage, workplace safety and overtime. The labor laws protecting contractors, on the other hand, are more likely to be geared towards payment and invoicing regulations and the terms of the agreements drawn.
When it comes to liability and insurance, employers are responsible for employees’ safety and conduct. Meanwhile, contractors are held personally liable.
Is a contractor agreement always the right solution to hiring overseas?
Taking on a self-employed ‘gig worker’ may seem like the right choice at first for candidates that are overseas, but if the COVID-19 pandemic taught us anything, it’s that remote working is the future, and that where you’re based does not always equate to your relationship with your company.
How you classify workers shouldn’t be based on where they’re working from, but rather the kind of work they do.
While bringing on a contractor may seem to offer the most convenience at first glance, it won’t give you the same amount of commitment you’ll get from hiring an employee – especially a full-time one.
To make the right choice, make sure you’re thoroughly evaluating your employment needs before deciding on a specific classification.
9 reasons to convert your contractor to an employee
Converting contractors to employees has its fair share of positives. On the worker side, it gives them access to a steady income stream, benefits, and legal protection. On the business side, it means a potentially steadier workflow, increased productivity, and dibs on top performing talent.
Here are 9 reasons you may choose to convert your contractor into an employee:
An employee-employer agreement is exclusive and long-term by nature. Meaning you get increased loyalty from your worker and less likelihood that they will work with another business simultaneously.
2. Perks and benefits
By converting your contractor into an employee, you can offer certain perks and benefits that can act as an extra incentive to keep them put for longer at the organization.
With an employee on board, it becomes much easier to define a work schedule that works both for you and your workers. On top of that, how you utilize your worker’s talent becomes broader, since it’s no longer limited to the highly specific terms stipulated in a contractor agreement.
4. Long-term business goals
With a relatively constant workforce onboard, it’s much easier to define and plan out long-term goals.
5. Opportunities in career advancement
Career advancement opportunities are a major benefit of taking on an employee role. On the employer’s side, it gives you a chance to better map out the potential benefits your worker can bring on for the company in the future.
6. Team collaboration
Collaborating on projects becomes much simpler when the worker has a steady presence at the company.
7. Streamlined workforce management
Workforce management becomes more streamlined when there aren’t too many moving parties. It gives the workforce manager a better bird’s eye view and enables them to better figure out how to improve productivity.
8. Skill development
By converting a contractor into an employee, you’re able to more easily recognize where their talents lie and how to best develop and utilize their skillset.
We saved the best reason for last: Compliance.
Without realizing it, you may be misclassifying your workers, defining them as contractors when they should have been employees in the first place.
Converting them to employees, in this case, is a must.
Understanding permanent establishment and misclassification risks
When choosing whether to hire an employee or a contractor, it’s crucial that you understand the nature of what you’re hiring them to do and what classifications it falls into.
If authorities deem the agreement you make with your contractor to be more employee-driven, you may be accused of not offering your worker the benefits, security and legal protection they are entitled to.
When hiring overseas, there’s an adjacent risk to mention here: if you hire a contractor abroad, and local authorities decide this is a case of misclassification, you will also be accused of not setting up the permanent establishment needed to hire this worker.
Ok, I Definitely Want to Make a Contractor an Employee: What Next?
Once you’ve spoken to the worker, you’ll need to take steps to ensure that they are eligible to work as an employee. If they are in the US, this is as simple as having the new employee fill out form W-4, which is the Employee Withholding certificate, and form I-9 that acts as verification that they can work in the United States.
In terms of ongoing commitment, it will be the same as with any other employee. The member of staff will need to fill out a W-2 form each year. On the employer side, you’ll need to withhold taxes that include Federal Income Tax, Social Security Tax, Medicare and Additional Medicare Tax, and Federal Unemployment Tax.
No matter where your contractor is based, though, if they’re abroad, things are bound to get a little more complicated. You can’t legally hire employees who have permanent residence abroad. Usually, that means you’re left with two main options – either establish an entity or work with an EOR.
Establishing an Entity Abroad
Opening a legal entity is a foundational step in hiring employees abroad – specifically, for when you’re seeking to establish a more permanent presence in the country.
However, if you’re just dipping your toes into a new talent pool – say, hiring just one employee – establishing a local entity is likely to be an unnecessarily costly affair – and not worth the time and effort.
That’s where an EOR comes in.
Utilizing an Employer of Record
An Employer of Record (EoR) is a workaround that allows you to hire an employee without setting up your own legal entity in their country of residence. The EOR hires the worker on your behalf.
Because your EOR of choice is handling all the administrative workload involved, you don’t need to think about liability or heavy bureaucratic factors, and can gear your focus towards big picture matters. On the worker’s side, meanwhile, they have all the conditions of being an employee met, with taxes and SS contributions being taken care of, as well as benefits, vacation days, and more.
Top tip: Look for an EoR provider who also offers international payroll. That way, if you decide to expand into the new location further and set down more serious roots, you have a partner that can make that happen.
Convert your contractors into employees instantly with Papaya Global
Once you decide to convert your contractor into an employee, you’re going to need to complete the following steps:
- Add your employee to your payroll
- Set up their data in all your workforce software
- Set up their pay rate and employee details
- Ensure all these points are in complete compliance with local jurisdictions
Let’s just put it out there: this process tends to be a schlep. BUT it doesn’t have to be.
If you’re working with a single provider who manages contractors, employer-of-record, and global payroll, a lot of this is as simple as changing their status in a single system.
That’s where Papaya Global comes in.
Sidestep the complexities of establishing an entity abroad with pre-screened local in-country EOR partners that can hire your worker on your behalf, and then manage your entire workforce from a single dashboard, no matter where they are based, or the kind of worker they are.
Need to make some changes to classifications or existing worker relationships? Talk to an expert.
What is the difference between a contractor and an employee?
An employee is usually brought on for an indefinite period of time. They’re also entitled to benefits and certain legal protection.
Contractors, on the other hand, are self-employed and are brought on for a fixed period of time. They handle their own taxes.
Does the company control or have the right to control what the worker does and how the worker does their job?
The company will always have some control over what the worker is doing but the level of control will vary depending on whether this is a contractor in question or an employee.
In the case of a contractor, the employer will have more control in terms of defining the terms of the contract but less control on smaller-level factors, like work schedule. In the case of the employee, there’s more control involved in terms of schedule.