Contractor Conversion Guide: From Contractor to Employee

Converting a contractor into an employee is a significant decision that can benefit both your company and the individual contractor.

While contractors offer flexibility and specialized skills on a project basis, there are times when a more permanent, structured employment relationship is necessary. Whether it's to ensure compliance with labor laws, secure long-term talent, or gain more control over the work being done, transitioning a contractor to an employee can streamline operations and strengthen your team.

However, this process involves careful consideration of legal, financial, and logistical factors to ensure a smooth and compliant transition.

In this guide, we’ll explore the key reasons to consider this conversion, outline the steps involved, and provide insights to help you make the best decision for your business.

Top reasons to convert a contractor into an employee

Converting a contractor to an employee may end up being advantageous for both parties. Here are the top reasons to consider making the switch.

• Your contractor wants to become an employee: The contractor may like to benefit from the extra security and protections provided to employees. While many contractors enjoy the flexibility and freedom of contract work, others desire greater certainty in their long-term income. Employees are also entitled to mandatory employee benefits, receive equipment provisions, and are often protected by minimum wage and overtime laws.
• You want a more permanent arrangement: Contractors are often with a company for a fixed amount of time; until they have completed a short-term project or reached a specific budget. But If your contractors have been knocking it out of the park, you may want to offer them a full-time position at your company.
• You want to assume more control over the working relationship: An independent contractor is a self-employed worker. This means they retain control over their workload, schedule, and location. If you want to establish set work hours or dictate the contractor’s day-to-day workload, equipment, and work location, you’ll need to convert them to an employee. Treating a contractor as an employee is against the law and could mean they’re deemed misclassified. Making the full legal transition is the safer option. Learn more about the difference between employees and independent contractors.
• You want the contractor to play a more prominent role in your company: Contractors may stick to the job at hand with little involvement in the rest of your organization. Converting a contractor into an employee demonstrates that you’re invested. It helps assimilate them into the company culture, providing a better employee experience and leading to greater involvement.
• Your contract with the worker is outdated: It’s a common mistake to continue working with a contractor without updating or renewing their contract. These old contracts may not be up-to-date with changes in employment laws which can lead to compliance risks. Converting the contractor to an employee is an excellent way to refresh the work arrangement if the contractor wants to make the transition.
• You want to retain top talent and avoid poaching: Contractors can engage with multiple clients and may provide work for your competitors. This could lead them to accept an employment offer with another company. Suppose you want your contractor’s skills to be exclusive to your company. In that case, converting them to an employee and providing them with benefits like health insurance, social security, retirement savings, and paid time off (PTO) will ensure their loyalty.
• You want to save money in the long run: While contractors are a cheaper alternative to full-time employees on paper (as they don’t require benefits by law), they often need higher wages since they pay more in self-employment taxes and must cover their own benefits. Depending on the length of the work agreement, it may cost a similar amount to hire them as an employee and have them as long-term assets. 
• Your contractor’s contract isn’t compliant with international law: If you’ve hired a contractor in another country, the labor laws are likely different, which means your work arrangement may not be legit and could result in penalties. Converting a contractor into an employee is an excellent opportunity to refresh the work arrangement and ensure all paperwork is compliant.
• You want more solid protections for your company’s intellectual property (IP): Contractors are their own entities, meaning they can obtain certain rights to the work they produce. Certain countries default IP rights to independent creators over companies. Of course, you can request the contractor to sign an intellectual property agreement. However, you will have greater built-in protections if you convert the contractor to an employee.

Convert contractors into employees in 6 steps

Now that you know the top reasons to convert a contractor into an employee, here are the steps involved in the conversion process:

1. Calculate the total employer tax burden and other costs

The first step is to establish if converting the contractor to an employee is financially viable for the company. By calculating the total amount of additional expenses associated with hiring employees, companies gain a more realistic idea of the total cost. To do this, take the approximate salary figure and subtract the total tax burden and other expenses such as benefits, bonuses, and perks. 

Here are some of the taxes and other direct overhead expenses associated with the total cost of employees:

• The employer-paid portion of payroll taxes
• Travel expenses and reimbursements
• Training costs
• Equipment and technology investments
• Health, vision, and dental benefits
• Paid vacation and holiday pay
• Retirement savings
• Performance bonuses or sales commission
• Perks such as team-building outings, coffee and lunches, and holiday parties or bonuses

When approximating the contractor’s new salary, a straight conversion of the contractor wage to salary is unlikely to be financially feasible since contractors typically charge a higher rate to cover their self-employed expenses and personal income taxes. 

There are a few ways to develop a fair compensation structure. One way is to determine the contractor’s hourly rate and multiply it by 2,080 hours, the total number of hours a full-time employee generally works annually.

Alternatively, use Deel’s employee cost calculator.

2. Check legal viability 

Once you’re happy the conversion is financially viable, you’ll need to determine whether the contractor can legally become an employee. Each country’s governing body has its own tests to determine whether or not the new role constitutes employment.  

The US’s Internal Revenue Service (IRS ) follows common law rules for making this distinction. Resources like this can help you determine the legal classification of the workers and whether or not they can convert to employee status.

Note: If the contractor lives in another country, you must ensure you can legally hire them. This can involve opening a local entity, also known as a foreign subsidiary, or taking the easy route and hiring them through an employer of record (EOR).

An EOR is an organization that helps businesses hire and pay local and international employees without opening a subsidiary. They take on full legal responsibility for the company’s workers, sign and terminate contracts, pay their salaries, manage their mandatory employee benefits and perks, collect tax documents, and more.

While the EOR manages the technical aspects of your new business relationship, you are still in control of your employee’s workload, working schedule, and similar decisions. Hiring through an EOR is faster and simpler, especially if you have multiple contractors from multiple countries to whom you want to offer permanent positions.

3. Negotiate the new employment contract

Once you’ve done all of the behind-the-scenes checks and you’re confident that the conversion is viable and makes good business sense, it’s time to approach the contractor to negotiate the terms of the new arrangement. 

Using the approximate salary figure and benefits package, propose a compelling employment offer. Remember, if a contractor starts working a full-time job for your company, they’ll likely need to drop any other projects and clients. That will affect their finances, so offering a competitive annual salary and an attractive benefits package is key to getting them on board. 

Contractors are used to freedom within their work, so it can be a good idea to ease them into the full-time employee arrangement with some flexible arrangements such as remote working, unlimited PTO, and flexible working hours. Your existing full-time employees will appreciate this flexibility, too.

Top tip: Having a contractor conversion policy can reduce uncertainty among your team when considering bringing on talent full-time. Deel’s free contractor-to-employee conversion template is specially tailored for international teams with contractors in more than one country. 

4. Sign an employment contract 

Once the worker has agreed to transition to full-time employment with the company, the next step is to create an employment contract. While a contractor agreement outlines the scope of work, an employment contract lists the required job duties and responsibilities involved in the role. It must also include information on the following: 

• Working hours and schedule
• Compensation and benefits
• Time off, sick days, and vacation policy
• Employment period
• Termination and severance
• Confidentiality and privacy

5. Collect employee information 

Likely, you’ll already have some information on your contractors from their invoices. However, there are additional tax forms and other documents to complete with employment. 
 
For example, employers require employees to fill in and submit tax forms W-4 and W-2 in the US.
 
You may also need to collect information regarding employee benefits. For instance, if you provide childcare assistance, you need to know how many children your new hire has. If you offer student loan repayments, you’ll need to know how much debt they have. If you provide private healthcare packages, you may need to know how many family members the employee has to ensure them.
 
In addition, some employers require all employees to undergo a thorough background check to confirm they have a clean criminal record. 

6. Add the new employee to the company payroll

Paying your contractor’s invoice differs from paying them a salary as it involves payroll tax deductions and withholdings. 

The first task is to add the employee data you collected in the previous step to your payroll software. If the employee is a resident of another country, you’ll need to set up international payroll to handle currency conversions, bank transfer fees, and exchange rates. 

Your HR department should also enroll the employee in any benefit programs depending on their entitlements. 

7. Commence onboarding

Now that your contractor has officially joined the team as an employee, it may be appropriate to introduce them to other team members and explain any new day-to-day commitments. For example, they may need to attend specific meetings, track client time, or update their Slack status if they’re out for lunch. 
 
An orientation call is an effective way to get the new employee up to speed with your day-to-day operations while integrating them into the company.

Convert your contractor to an employee with Deel

Deel helps companies with streamlined hiring of full-time employees and independent contractors and simple conversion between the two. 

Our all-in-one solution also provides the following:

• Contracts that are compliant with local labor laws
• Global payroll, including multiple payment methods, local payouts, and currencies
• Tax form collection and electronic filing
• Compliance documentation to avoid misclassification risks worldwide
• Global hiring and international employment

Want to learn more about the easy way to hire and pay workers? Book a demo today.