How (And Why) to Transition from Contractors to Employers of Record

Erez Greenberg October 13, 2020
Person holding a globe

Working with independent contractors, at first glance, has many advantages. There are no taxes to calculate and withhold since contractors are paid in a lump sum and handle their own tax payments. They are not subject to labor laws, so there are no health insurance, pension payments, or overtime costs. There are no additional costs to the employer, who pays for the work done and nothing else.

Perhaps most important of all, there is no legal liability – other than making sure that contractors are classified correctly and not functioning as employees. Contractors work on their own, in their own space, and under no direct supervision. They are self-employed and maintain liability for their work. They are temporary workers and come and go as they please.

This transient quality makes contractors ideal for short-term projects. But when projects get longer and more complex, companies require more than temporary help. They need people who will be involved day-in, day-out. There is a need for supervision and guidance as the volume of work increases. In other words, at some point, growing companies need employees. At this point, companies run the risk of misclassification if they continue to rely solely on contractors.

Today, companies have an option that lets them keep the easy payroll and no liability, but with the permanence they get from employees. They can work with an Employer of Record (EoR). The EoR (global peo) serves as the legal employer, handling all of the payroll functions and assuming all liability. The client, however, directs the employees in their day-to-day work.

From the client’s perspective, working with an EoR or global professional employment organization is similar to working with contractors. The EoR serves as an outsourced back office, handling all of the workforce management tasks such as tracking time and attendance and withholding taxes. But the employees are permanent, not freelancers, and there is no risk of misclassification error.

The transition from contractors to EoR can be an involved process but with the help and guidance of an experienced EoR, it can be simple. This guide will show what’s involved in making the transition.

Understanding Contractor Misclassification

While misclassification is a global problem, and governments – eager to protect the rights of employees and to collect employer taxes – have been cracking down on the practice in recent years with greater intensity; the information in this section refers specifically to the standards and practices in the US.

An employee works part-time or full-time under a written employment contract or verbal understanding with the employer, has a specified role within the company, and has recognized rights such as minimum wage and extra pay for overtime.

A contractor is not under the control, guidance, or influence of the client. The contractor is able to decide what and how things are done and the client only determines the result of the work.

The primary difference between contractors and regular employees is autonomy. Contractors are independent. Employees are under the control of the employer. The IRS lists three categories to explain the differences in the two designations:

  1. Behavior Control – If an employer has the right to direct and control how work is performed or where it is performed, such as by providing office space to the worker, the worker may be an employee, not a contractor.
  2. Financial Control – Employees are paid in regular intervals, receive reimbursements for expenses, and if they require specialized equipment, it is provided by the employer. Contract workers are paid in one lump sum, do not receive reimbursements, and invest in their own equipment.
  3. Nature of Relationship – If a worker is providing a service that is vital to the business on a regular basis, and especially when the relationship is viewed as permanent between the worker and the company, the probability is high that the worker should be classified as an employee.

Governments have been cracking down on misclassification error and levying heavy fines on violators. As companies grow and require more involvement from their contractors, it is very easy for a company to slip over the line that separates contractors from employees, exposing themselves to fines. Reclassifying them as employees eliminates that risk.

Benefits of Transitioning Contractors to EoR

If your company wants to maintain control of the workplace and how the employees carry out their tasks, it will need to stop relying on independent contractors. Reclassifying all or some of the contractors already working has a number of advantages:

  1. Ability to attract a higher calibre of motivated employees because of an improved compensation package, including benefits
  2. Full legal compliance
  3. Maintaining continuity on projects already in the works
  4. Ability to secure the services of skilled employees through long-term contracts
  5. No risk of misclassification

Making a change in classification may impact your company’s overall workforce spending since employee benefits and employer taxes are added to the equation. But the difference may not be substantial because contractors charge more in hourly pay to compensate for the additional costs. Since the employees will be permanent, the EoR model allows for greater stability for both the employer and the employee.

Steps in the Transition Process

Step 1 – Partnership with EoR

The transition begins when a company partners with an EoR to begin hiring abroad in legal compliance. The EoR will then direct the company in the necessary documentation and the operational steps, since contractors in most countries require different tax forms than employees. In the US, for example, the 1099 form for contractors is replaced with the W-2 form filed by the EoR for each employee.

The EoR will set up accounts for each employee with all of the local tax authorities and social security offices, and provide all of the mandatory benefits. It will track time and attendance for each employee.

As the local expert, the EoR will also help smooth the transition for people who are accustomed to the autonomy of self-employment and provide representatives to answer any questions for the new employees.

Step 2 – Communication with the Contractors

The process of moving contractors over to a new designation requires careful and sensitive communication with all of the people impacted by the move. In most cases, the contractors will benefit from the move and welcome the change.

Be as transparent as possible with the employees, and let them know why you decided to make the change, what it means for the company, and how both the company and the employees will benefit from the move.

It is important to explain specifically what the change in status will mean. Some of the benefits employees may receive (depending on location) include paid time off, maternity/paternity leave, sick leave, pension, termination rights according to labor laws, and participation in the company health insurance plans.

It will also place the employees under greater control from the employer than they are accustomed to. Show them how their projects require a deeper collaboration between the company and the employee than possible under a contractor relationship.

Step 3 – The Employment Contract

Once the contractors agree to the proposed change, they need to sign an employment contract with the local company that will serve as the legal employer. The contract must be in the local language and list the terms of employment. These will vary from country to country but each will be in compliance with the full legal requirement for each country.

The EoR will provide the contract, with all of the elements required in each location. The contract, however, serves as an excellent opportunity to approach each employee personally and explain the change directly.

Make sure that each employee knows where to turn if there are any questions or problems with the payroll. Contractors are used to being in full control of all aspects of their professional lives. Transitioning to employees can add levels of security and increase benefits. The more connected they feel to the company and the process, the more comfortable they will be with the change.

Get the Papaya Experience

Papaya Global is an EoR aggregator in over 140 countries, joining with an independent in-country partner (ICP) in every country it serves.

It offers a total workforce management solution supporting all types of global workers (payroll, EoR, and contractors). The automated, cloud-based SaaS platform provides an end-to-end solution, from onboarding to on-going management to cross-border payments.

The automated platform ensures payroll compliance, provides benefit management, and ensure data privacy in compliance with GDPR. Papaya’s knowledge center provides updated information on salary benchmarks, mandatory benefits, tax rates, and more – everything you need to know before hiring overseas.

Contact us for a strategic consultation. We can help with budget planning, compliance, and a plan for management and communication to move your contractors into an EoR framework wherever you are hiring.

Papaya Global payroll platform lets you:

  • Automate payroll with zero processing errors
  • Manage global payroll, PEO & contractors via one platform
  • Make cross-border payments in 140+ countries