Working with contractors has a lot of benefits. In many cases, companies may choose to engage with a freelancer or a contractor to get access to niche, skilled expertise without the need to pay social security, healthcare and other benefits, or employee taxes.
However, if you’re looking to take on a contractor on a more permanent basis, either because you love their work and contribution to the company, or you’ve realized you may be misclassifying them in the first place – here’s what you need to know.
Does it Matter if my Contractor is Overseas?
Taking on a self-employed ‘gig worker’ may have seemed like the right choice at first if your candidate was overseas and would be working from abroad, but if the COVID-19 pandemic taught us anything, it’s that remote working is the future, and that where you’re based does not always equate to their relationship with your company.
Rather than think about where your staff are working from, the definitions should be based on the kind of work that they do. A full-time employee will be bound by your employment contract, and provided a set salary or wage based on the hours that they work, paid out on regular payment cycles. They will often use equipment and processes that have been agreed by your company, and their managers will dictate when they work, and the scope of what they do. In contrast, as a freelancer, a self-employed worker will take on short-term, often ad-hoc projects, and usually set their own rates, hours, and involvement.
A contractor may love their independence and flexibility, but with the commitment, a full-time employee gets a range of mandatory and non-mandatory employment benefits. In the United States, the Federal Insurance Contributions Act (FICA) mandates that organizations provide their employees a benefits package that includes compensation, a contribution to a retirement plan, paid vacation days, and health insurance. They also receive protections as laid out in the Fair Labor Standards Act (FLSA), something that freelancers aren’t covered by.
The Key Differences in How You Report Your Workers
If your member of staff is an employee, you’ll need to fill out form W-2 and withhold taxes. If they are a contractor, they are responsible for their own taxes, but if you paid more than $600 to any worker – as of 2020, you must fill out a 1099-NEC form. On the contractor’s side, if they are overseas, they will need to fill out form W-8BEN.
If you’re still not sure whether the member of staff in question should be an employee or a freelancer, you can file form SS-8 with the IRS, and they’ll give you the right classification. If you think that you may have made a mistake with misclassifying employees as contractors, and you know that there will be penalties as a result, you might be eligible for the Voluntary Classification Settlement Program, which can offer some tax relief.
Ok, I Definitely Want to Make a Contractor an Employee: What Next?
Once you’ve spoken to the worker, you’ll need to take steps to ensure that they are eligible to work as an employee. If they are in the US, this is as simple as having the new employee fill out form W-4, which is the Employee Withholding certificate, and form I-9 that acts as verification that they can work in the United States.
In terms of ongoing commitment, it will be the same as with any other employee. The member of staff will need to fill out a W-2 form each year, and need to switch from the 1099-NEC to this. On the employer side, you’ll need to withhold taxes that include Federal Income Tax, Social Security Tax, Medicare and Additional Medicare Tax, and Federal Unemployment Tax.
If your contractor is abroad, things get a little more complicated. You can’t legally hire employees who have permanent residence abroad to work for your US company. That means that you have two main options.
Establish an Entity Abroad
There’s no escaping it – having a legal entity is a foundational step in hiring employees abroad. However, while you might feel certain that your contractor is offering great-quality work and would be a fantastic cultural fit, the expense of setting up an entity for a single member of staff can be seriously prohibitive.
There are costs involved in establishing the legal entity, and also additional costs involved in closing it again, if and when your new employee decides to move on. There’s also a learning curve in offering the right benefits, salary, equipment and partners in a brand-new location, the costs of which can add up fast. Setting up an entity can also take time, while you file paperwork, get approvals from the necessary government offices, and hire accountants or lawyers in-country to help you find your feet. Even a small task such as setting up an employment contract can be more complex than you first considered. For example, in France, employment contracts need to be written in French. Parlez-vous français?
Utilize an Employer of Record
An Employer of Record (EoR) is an intelligent workaround that allows you to hire your contractor as an employee, without setting up your own legal entity in their country of residence. You work with a local in-country partner, who hires the contractor as an employee on your behalf.
As your company engages directly with the EoR, you don’t need to think about liability or administrative overhead, you can simply engage with the new employee and their day-to-day workload and needs. On the worker’s side, they have all the benefits of being an employee, with taxes and SS contributions being taken automatically from their paycheck for example, as well as benefits, vacation days, and more.
Top tip: Look for an EoR provider who also offers Global payroll. That way, if you decide to expand into the new location further and set down more serious roots, you have a partner that can make that happen.
3. Practical Steps
Now that you can legally take on this employee – make sure that your processes are up to scratch! Add your employee to your payroll, your T&A software, your project management software, and any other company processes that they need access to. Set up their pay rate, their employee details, their email account, and more.
If you’re working with a single provider who manages contractors, employer-of-record, and global payroll, a lot of this is as simple as changing their status in a single system. This is exactly what Papaya Global does best.
Sidestep the complexities of establishing an entity abroad with pre-screened local in-country EOR partners that can hire your worker on your behalf, and then manage your entire workforce from a single dashboard, no matter where they are based, or the kind of worker they are.
Need to make some changes to classifications or existing worker relationships? Talk to an expert.