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How to convert independent contractors to employees: A guide for distributed companies

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October 18, 2021
Oyster Team
How to convert independent contractors to employees: A guide for distributed companies

While converting individuals from independent contractors to employees isn’t necessarily difficult, it is time-consuming—especially for overseas hires. 

Not only will you need to change the way you pay, tax, and assign the person work, but you’ll have to do so in a punctual and compliant manner. Fall short, and you could receive handsome fines. 

This quick guide will walk you through the basics of how to convert independent contractors to employees as a distributed company.

We’ll start by briefly explaining what each is, follow with reasons why companies even bother converting independent contractors to employees, and finish with tactical steps you can take today to get the ball rolling with your new international hire.

Independent contractors vs employees: High-level overview 

Independent contractors, also commonly called freelancers, are self-employed individuals who provide services or products to other companies. 

They do their own taxes, maintain their own equipment, and level up their skills as needed, among other self-reliant tasks.

Employees, on the other hand, are full-time workers bound by employment contracts and paid on set cycles. 

They use company equipment, undergo company training as seen fit, and generally work on the premises (in traditional, non-distributed companies).

Why bother converting independent contractors to employees?

Graphic that says "why convert independent contractors to employees"

Different companies may have different motives when converting from independent contractors to employees. 

Three common reasons are: 

The contractor is at risk of becoming misclassified

There is no definitive answer when determining if someone should be classified as an independent contractor or an employee.

But what is known is that misclassified workers bring about many risks for distributed companies, the least of them being steep fines from failing to pay the appropriate taxes.

This is why it’s important to do your homework beforehand and to make the decision on a case-by-case basis. Check out this contractor assessment to help get you started.

The contractor is a very strong team member

Does the independent contractor always turn exceptional work in on time? Are they intricately involved in company growth? Do you have a strong employment relationship with them?

Well, these could be reasons to offer them a full-time position, especially if the possibility of losing them to another company makes you queasy. 

The contractor wants full-time employment

On the other hand, maybe the contractor has requested to become a full-time employee. 

Full-time employment brings with it many perks for workers, some of which include: 

  • Minimum wage requirements and hourly wage
  • Paid time off and vacation pay
  • Worker’s compensation insurance
  • Unemployment insurance 
  • Health care
  • Retirement savings plans 
  • Wellness programs
  • Professional development opportunities 

Factoring in all these and more, it’s not hard to see why some contractors would request to be switched to employees.

How to convert independent contractors to employees internationally

Graphic that says "how to convert independent contractors to employees internationally"

Depending on where your distributed company’s headquarters are located, the steps to convert independent contractors to employees may vary, yet the framework will stay relatively the same. 

Therefore, for this blog, we’ll follow those done by distributed companies based in the United States. Adapt them as needed based on your own country’s labor laws.

And as always, seek proper legal advice or a second opinion before initiating the process.

Verify worker classification

When determining employment, answering “yes” to any of the following questions is a strong indication that the worker is an employee:

  • Do you supervise the person while he or she is working?
  • Can the worker be fired at any time?
  • Is the work being performed a necessary part of the business?
  • Are your other employees doing the same type of work? 
  • Do you provide the tools, equipment, or general supplies needed to do the work? 
  • Do you provide training for the worker?

If you need further clarification, refer to the contractor assessment we linked above. You can also file Form SS-8 with the IRS, and they’ll determine the employee status for you. 

Notify the worker in writing

Whether the contractor requested to be converted to an employee, or it was an internal decision, notify the worker in writing.

This way, there is a physical record on file in case the company is audited, or there are any discrepancies later down the road.

Gather employee documents 

In the U.S., documents needed to legally convert independent contractors to employees can include federal and state forms, such as:

  • Emergency contact information 
  • Job offer letter
  • Signed employee handbook
  • Insurance enrollment forms (if applicable)
  • Company property checklist
  • Among others

Adjust payroll promptly

Once the switch to full-time employee is successful, he or she will need to receive wages through payroll. 

Wage statements in the U.S. reflect paid sick leave, health insurance, vacation, and paid time off, among other benefits. 

Employers will also need to pay employment taxes if the full-time employee is a resident of the United States. This includes, but isn’t limited to: 

  • Federal income tax
  • Federal unemployment tax (FUTA)
  • Social security and Medicare taxes (FICA)
  • Any state or local taxes

It’s important to make these payroll adjustments immediately. If you don’t, you may owe back-tax on the amount of payroll taxes your company should have paid.

Onboard the employee properly

This goes without saying, but after converting independent contractors to employees, hold them to the same standards as your current full-time workers. 

The new hire should receive the same employee benefits; abide by company handbooks, policies, and employment agreements; undergo annual reviews; receive overtime pay; etc.

Also, as they’re onboarding, make sure they virtually meet the rest of the team. Pair them with a senior team member who can help acclimate them, and provide them with the tools and equipment they need to succeed.

Distribute necessary end-of-year tax forms

Which end-of-year tax documents to turn in depends on if the employee is a resident or non-resident alien of the United States.

If the new employee is a resident of the United States, your company will need to turn in Form W-2 to document year-end earnings (no longer a 1099-MISC).

However, this changes if the employee is not a U.S. resident, nor working within the United States, otherwise known as non-resident aliens for tax purposes. 

For non-resident aliens, your company will need to fill out Form 1042-S, a year-end federal tax document given to those who received wages that were exempt from federal and state tax withholding. 

It’s important to note that in some instances, foreign nationals may receive a W-2 form in addition to a 1042-S for the same tax year.

Establish a subsidiary company

If the independent contractor you’re converting to an employee resides in another country, opening a subsidiary company could be the solution for you.

By opening a local branch of your company in the employee’s country, you’ll be able to hire the candidate as a local employee, reducing the amount of paperwork normally involved with international hires. 

The best way to go about doing this compliantly is to contact someone educated in the country’s local employment laws to help.

Check out these country profiles to find out more about local employment regulations and employer/employee taxes in over 50 countries. 

Use an EOR service to simplify the process

Graphic that says "EOR services take care of international employment, payroll, benefits, and compliance"

Employer of Record (EOR) services take care of international employment, payroll, benefits, and compliance by helping you calculate the cost of your hire, create personalized contracts, manage global payroll from one place, and much more. 

Essentially, you outsource the normal HR headache from hiring for a distributed team.

Final thoughts

Converting independent contractors to employees is a big step for employers and employees alike. 

For employees, the promise of benefits, professional advancement, and steady work could make the decision an easy one. Whereas, as the employer, your company is investing in the long-term growth and development of a valuable addition to the team. 

As we’ve warned before, if this process is done improperly, your business could be flagged and audited, resulting in steep fines, grueling headaches, and lots of wasted time for all parties involved.

Do you know how to distinguish the difference between an independent contractor and a sole proprietor? Our legal team explains in this blog post.

Disclaimer: This blog and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.

About Oyster

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

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

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