Contractor vs. employee
Understanding misclassification
Why transition contractors to full-time employees?
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Oyster’s guide to converting contractors to full-time employees

Discover how to approach the conversion process from contractor to full-time employee.
September 1, 2022
Oyster Team

For many businesses, working with contractors can be a flexible and practical solution for highly specialized, project-based, or time-bound work. But contractors and full-time employees have substantive differences. 

This means that organizations should take great care to minimize their risk of misclassification by converting contractors to full-time employees whenever there’s a change in the working relationship, context, or scope of their work. 

In this guide, we’ll go over the differences between a contractor and an employee, potential risks, reasons to consider converting a contractor to an employee, and how businesses can get started managing this process with Oyster.

Contractor vs. employee 

To some, it may seem like the differences between a contractor and an employee are in name only. If a contractor and an employee are both brought on board to do a job, why is it necessary to draw a distinction between the two? Well, these two worker classifications have major differences in rights and responsibilities, and a failure to consider these distinctions could have significant legal implications.

First, let’s start with a few basic definitions and criteria for classifying independent contractors and employees. 

Independent contractor

A contractor is someone who enters into a contract for the performance of services with an organization but is not legally employed by them. As the IRS explains, “you are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done).” 

Oftentimes, companies will engage contractors for niche specializations and expertise. Their work is largely independent; they may have other clients; and the scope of their work may be limited—unlike a full-time employee, whose role and responsibilities may be more generalized and supports the nature of the company’s general business. 

For the most part, contractors are self-employed, meaning they are responsible for their own tax affairs. When they are paid for their services, it is their responsibility to make the appropriate tax contributions in line with their jurisdiction (country, state, city) and liabilities.

Full-time employee

A full-time employee is a worker who is hired directly by an organization, and is subordinated from a technical, economic, and legal viewpoint. The company as the employer is responsible for training them in their role, ensuring their benefits are compliantly administered, and providing guidance and instruction on how the work should be performed. 


What is the difference between a contractor and a permanent employee?

Contractors and full-time employees often work on the same teams, take part in the same meetings, and collaborate with the same people. However, there are important factors around benefits, pay, and risk which underscore clear differences between a contractor and an employee. 

Difference between full time and contract workers

Benefits

In most cases, companies do not provide a contractor with benefits like: 

• Healthcare
• Sick pay
• Paid time off
• Parental leave

A contractor may charge a higher hourly, daily, or project-based fee to be able to cover these expenses on their own. Employees, however, are entitled to certain statutory benefits, depending on the employment laws of their jurisdiction.

Salary

How a contractor is paid often differs from how an employee is paid. Frequency, method, and process can vary. For example, a contractor may track their hours or output and submit a monthly invoice in order to receive payment. Full-time employees, however, do not need to request payment or submit an invoice for their work. Their salary is most likely administered on a monthly, biweekly, or weekly basis with necessary withholdings made on the employee’s behalf. 

Taxes

Contractors submit invoices for payment for their work and are obligated to manage their own tax contributions. Contractors are responsible for declaring and paying tax on their earnings. It is common for full-time employees to have their taxes deducted by their employers as they earn. 

Exclusivity

While full-time employees can technically have more than one job, it is less common. However, it is very common for contractors to take on multiple clients or projects at once. In fact, this is one of the key indicators of a true contractor. Contractors are trading on their specific expertise, so it is often financially beneficial to work on multiple projects at a time.

Risk

While hiring a contractor does afford companies flexibility and access to specialized talent, there is significant risk associated with misclassification. Misclassification of a worker as a contractor versus an employee can result in penalties and fines as well as reputational damage.

But what exactly is misclassification and how can it affect companies?

Understanding misclassification 

Misclassification can happen when a worker is designated as a contractor but is treated like an employee and operates like one within an organization. But is there a test to determine whether someone is an employee or independent contractor?

In the United States, the IRS uses the following common law test to determine whether the designation of employee or contractor is most appropriate. However, keep in mind different tests are used by different agencies and by the various states within the United States (and other tests in other countries), as a result, it is important to understand what test to determine worker classification will be applied. The following is an overview of the common law test applied by the IRS:

Behavioral

Does the company control or have the right to control what the worker does and how the worker does their job?

Financial

Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

Type of Relationship

Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Example of potential misclassification 

Consider a contractor who is brought on board to work on a six-month web project. The organization provides them with equipment and strictly dictates the hours they’re expected to work and the specific tasks they’re expected to work on. The company wants the project done on time, so they suggest that the contractor pause their other client relationships. In addition to all of this, the contractor is also given a company email address. In this instance, there is likely a substantial risk of misclassification. 

In the example we used, there is a high degree of behavioral control, and the tools for the project have been supplied to the worker by the company that has engaged them.

While factors like a company email address are less important to misclassification risk, the company’s control over working hours and tasks is significant in assessing whether they can be classified as an employee or contractor. 

The penalties for employee misclassification can vary and will depend on the specific circumstances. These can include tax fines and penalties, compensation for missed benefits, unpaid wages, and costs associated with lawsuits filed by the worker(s) themselves. 

While misclassification criteria can vary from country to country (and even from state to state), Oyster’s contractor vs. full-time employee analyzer can help you to better understand this risk.

Why consider transitioning contractors to full-time employees?

There are a number of reasons to consider transitioning contractors to full-time employees. While some of the reasons are more practical, there are many compliance considerations to take into account as well.

A change in circumstances

A company’s needs can evolve quickly, and its relationship with a contractor may change. For example, after engaging a contractor for one project, it may become clear that they are particularly effective. The relationship may become more akin to an employee relationship, with a company bringing the contractor aboard for additional assignments over which the company exercises more control. Some of these assignments may be integral to key aspects of the business, which may, in turn, put the company at risk of misclassification. Regular audits of the contractor relationship are recommended to ensure that it doesn’t quietly evolve into an employee relationship. 

Attrition

A contractor may prove to be a high performer or become an integral part of key projects and initiatives. If they are not a permanent employee, there is always a chance of attrition or worse, losing them to a competitor if there is no non-compete agreement in place or if the non-compete is unenforceable. An overreliance on contractors can present an operational risk if they end the relationship or move on. 

Data privacy 

Over the course of their work, a contractor may come into contact with sensitive or proprietary material. In the area of data privacy, it’s important that the contractor is processing and handling data appropriately, just as is expected for employees. Practically speaking, it’s easier to enforce the use of compliant systems and processes for employees because there is already some expectation of behavioral control and compliance training provided by the company. 

Disengagement  

Because it is unlikely that a contractor has been granted the same benefits as permanent employees within a business, disengagement can occur. The contractor may feel disadvantaged in their development opportunities, equipment, perks, and general benefits.

Permanent establishment risk

When it comes to permanent establishment risk, where a contractor is based matters as much as the nature of their work. A company may be at risk of permanent establishment based on fixed place of business, dependent agent activities, and extended provision of services. Consequences for even inadvertent permanent establishment include additional local corporate tax responsibility and more. 

Addressing a business need

As the relationship with a contractor evolves, you may find that their skills and experience match those that are needed to fulfill a specific business need. In that case, deciding whether to transition them to a full-time employee becomes more straightforward. An established relationship, understanding of the company environment, and familiarity with teams and cultures within an organization can create an ideal situation for a contractor to transition into.


Top questions and further reading about transitioning contractors to employees

Naturally, there will be some key points to consider when beginning the process of converting contractors to full-time employees. We’ve written about these considerations in detail across the Oyster library in addition to what’s in this guide.

What are the risks of working with independent contractors? 
How do you know when it’s time to convert a contractor to a permanent employee?

How can you convince a contractor to become a permanent employee? 

Salary vs. contractor rate: How can you convert a contractor salary to an employee salary? 

Converting a contractor to an employee will require expert help, especially if they are located in another country. Oyster can help you manage this process from start to finish. 

Explore Oyster’s contractor to team member conversion tools

With our global employment platform, companies can engage talent in 180+ countries without needing to become local, legal, or employment experts. Transitioning a contractor to an employee is fast, easy, and compliant with Oyster because we handle the details so companies can focus on retaining great talent. 

To help you get started, try our tools for assessing contractor status and misclassification risk, exploring country-specific benefits, and calculating the cost of employment. 

Benefits advisor
Identify country-specific benefits including health, time off, allowances, and perks, so you can take better care of your newly converted Team Members.  

Global salary calculator
Calculate the total cost of employment in any country, including taxes, contributions, and the Oyster flat fee.

Contractor vs. full time employee analyzer
Confidently assess workers for misclassification risks and explore the costs and benefits associated with each employment model.

Transitioning contractors to employees with Oyster

Misclassification risk, permanent establishment risk, and data and productivity concerns are all good reasons to consider transitioning a contractor to an employee. With Oyster, our employment tools and experts can help:

• Assess misclassification risk
• Calculate the cost of converting a contractor to an employee
• Navigate the transition from both the company and contractor sides
• Deliver country-specific and compliant contracts and onboarding processes

Oyster’s platform and experts will ensure that your business is able to avoid misclassification and permanent establishment risk, manage a smooth contractor transition, and compliantly engage with and offer benefits to new team members. Ready to get started? Book a consultation to speak with a member of our team.

About Oyster

Oyster is a global employment platform that empowers visionary People Ops leaders to manage and care for a thriving global workforce. Through its compliant hiring process, streamlined payroll, and localized benefits offerings, companies can bring talent aboard no matter where they're located.

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