When does an independent contractor become an employee?

Independent contractors bring several advantages to organizations. They can offer the same skills and expertise as in-house employees without the costs of additional payroll taxes and compensation packages. Thanks to their specialized expertise, most contractors can be productive immediately, reducing the time you’d ordinarily spend on onboarding activities. Contractors also allow for greater staffing flexibility, since you can only hire them for a short duration to assist with a specific task or project. However, your company’s needs change over time, meaning your staffing needs are likely to evolve as well. Here’s what you need to know about helping a contractor become an employee.

While keeping the benefits we listed in mind, there may come a time when it makes sense to convert an independent contractor to a full-time employee. So, when does an independent contractor become an employee? Here are some indicators that the transition should be considered:

• Your need for the contractor’s services is becoming permanent. 
• The contractor is performing core business services.
• The contractor is ready to work exclusively for you and will no longer lend their services to other clients.
• You have enough work to keep the contractor busy on a part- or full-time basis
• You have the means to provide the equipment or supplies the contractor needs to carry out their role.
• The financial benefits of hiring the contractor as an employee outweigh the costs.

In many cases, the advantages of turning a great contractor into an employee make the transition worthwhile. After all, these professionals already understand their role and have the skills needed to succeed in it. They may also have established professional relationships within the organization, as well as gained knowledge of your company’s culture, mission, and strategic vision. However, there are some steps you’ll need to take to ensure a smooth and seamless transition.

Switching from an independent contractor to an employee

The independent contractor-to-employee conversion comes with several legal considerations. For one, employees should be on the payroll and receive a steady paycheck, whereas contractors typically submit invoices and are treated as vendors under accounts payable.

Moreover, employment and labor laws will now apply to the employee, although they did not apply to the individual when they were an independent contractor. This means that under US labor laws, the employee will now be:

• Protected against discrimination, harassment, and unfair treatment in the workplace.
• Eligible for applicable compensation under the Family and Medical Leave Act (FMLA).
• Protected against wrongful termination of employment.
• Eligible for workers’ compensation for illness or injury on the job.
• Able to complain about unsafe workplace conditions without ramifications.
• Entitled to minimum wage and proper compensation for overtime.

It’s also important to consider that employees are protected against being misclassified as independent contractors (Tip: Try our contractor vs. full-time employee analyzer to assess and confidently classify your workers). The Internal Revenue Service (IRS) uses the right-to-control test to determine whether an individual is a contractor or employee. This test assesses financial and behavioral factors, as well as the type of relationship between the worker and the company. If your company is treating an individual as an independent contractor when they should really be considered an employee, you could face legal consequences.

In addition, employers become responsible for taxes when a contractor becomes an employee. While you don’t need to withhold taxes for contractors, the organization will need to withhold income tax, Social Security, and Medicare from the wages paid to an employee.

Finally, you’ll need to consider how compensation will change when switching an independent contractor to employee status. The employee may now receive an hourly rate or salary, as well as benefits such as paid time off, retirement planning options, and health insurance.

Undergoing independent contractor-to-employee conversion

Transitioning an independent contractor to an in-house employee means taking the following steps:

Create a formal job offer

Note that the contractor is not obligated to accept an in-house position. If they decline, they must continue to be treated as a contractor—not an employee—so that legal requirements are met.

Start an employee file

In the US, there are several documents needed to convert an independent contractor to an employee. These may include federal and state forms, such as:

• The job offer letter
• A signed employee handbook
• Forms for insurance enrollment
• Emergency contact information
• A checklist of company property

Add the employee to your payroll

Once the contractor has accepted employment with your company, you’ll need to set them up through payroll. In the US, wage statements reflect paid time off (both for sick days and vacation) and health insurance, as well as other benefits.

You’ll also need to pay employment taxes if your employee is a US resident. This can include federal income tax, Social Security and Medicare, federal unemployment taxes, and any other state or local taxes. Additionally, you’ll need to have the employee complete a W2 form to report employee wages.

Be sure to adjust your payroll processes as soon as the contractor starts work as an employee. Otherwise, you may wind up owing back taxes on the payroll taxes you should have been paying.

Onboard the employee

Since your contractor will now be an in-house employee, it’s important to hold them to the same standards as other employees throughout the company. This means they should abide by any company policies and employee agreements. Onboarding activities may include steps such as training/orienting the employee, signing an employee handbook, meeting with the rest of their team (either virtually or in person), offering mentorship, and setting up a company email address for them.

To streamline your onboarding activities, turn to Oyster. We’re here to help you find and hire remote contractors and employees anywhere in the world.

About Oyster

Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.