How to Convert a Contractor Rate to a Permanent Salary?

Modern businesses typically employ a mix of contractors and full-time employee staff. The former are temporary workers engaged on a temporary basis to fulfill contractually predetermined tasks. Their work schedule is flexible, and the employer’s control over their operations is loose. The latter, in turn, are formally employed experts with a full-time contract that presupposes social benefits, tax deductions, and full control over their work schedule and duties on the part of the employer.

This way, each of the employment relationships comes with a set of pros and cons. Permanent workers get the stability and universal coverage of their benefits and obligations from their employer while sacrificing the flexibility of working for multiple employers and at individual schedules. Contractors enjoy the flexibility and freedom of partnering with several clients while at the same time having no benefits and managing their taxes independently.

While each of the worker types may have their own motivations to stay in that designated role, a business may consider the transfer of contractors to full-time employee roles in specific situations. Whether it relates to talent retention or compliance management, such a step is always less risky for businesses.

Yet, it’s a multi-step process that requires attention and diligence so that everything is done correctly and to the mutual benefit of all stakeholders. One of the key aspects of this transition is the conversion from contractor to full-time salary. Contractors are typically compensated on an hourly rate basis or receive payment in line with contractual terms. Full-time employees’ rates are calculated differently, so the process of transition may become problematic.

To help you navigate this complex landscape of permanent salary establishment, we’ve compiled this guide with expert tips and considerations. Read on to master the fundamentals of salary recalculation and ensure the transition goes smoothly.

Steps of Conversion from Contractor to Full-Time Salary

The process of turning the contractor rate to permanent salary is a tedious one since you need to take many aspects into account. While a contractor usually gets a plain rate for their rendered services, with no additional obligations on your part, full-time staff receive only a clear salary. Therefore, to determine how much you need to pay to a former contractor shifting to full-time worker status, you need to perform the following steps.

#1 Use Hourly Rates to Calculate a Monthly/Annual Salary

Your contractors receive hourly rates for the work they do, and the simplest math will be to multiply the hourly rate you pay by 2,080 hours – a standard number of working hours an employee spends in the workplace per annum. As a result of this calculation, you get the employee salary rate before deductions. This should be your starting point in the following calculations.

#2 Deduce Taxes and Other Costs

Since the original sum you’ve received by multiplying the hourly rate by 2,080 hours is the full sum your employee should cost you per year, this sum includes all additional expenses, benefits, and taxes you pay for this worker throughout the year. Now, it’s time to find out how much of this money will go to tax agencies, how much you will spend on their workspace, software, and equipment, and how much will be left for payroll. These considerations will lay the foundation of your contract to hire salary conversion.

First, you should calculate the percentage of taxes you will pay to local authorities – it’s the annual tax burden per employee that you will inevitably bear. Next, you should take the sum you spend on:

• Employee training.
• Office space rent.
• Equipment and software purchases.
• Office space maintenance (cleaning, food supplies, energy bills).
• Travel expenses for business trips.
• Social benefits.
• Health insurance coverage.
• Vacation costs.
• Retirement plan deductions.

Obviously, you should distribute the burden of these expenses evenly between your business and the employee. With contractors, you don’t bear any of these overheads. Still, you also get fewer benefits from their full-time employment, such as full-time commitment, intellectual property (IP) protection, and talent retention. Therefore, it’s vital to be objective and fair in the process of contract rate to full-time salary conversion so that each of the parties feels they get something beneficial from this rearrangement of the employment relationship.

Advantages and Disadvantages of Conversion of Independent Contractors into Employees

Turning your contractors into permanent staff definitely comes with many strategic benefits. They include:

• Risk reduction. Business risks associated with contractors are much higher than those of full-time staff. First, you continually face the misclassification risk if your contractors are dedicated to full-time tasks, sign an agreement to work only for you, or work for your company for a long period. Second, contractors are flexible and free partners that may leave your company at any moment, thus undermining IP safety.
• Better control. Every contractor is a sole proprietor – a person running their own business. Thus, their work with your company is primarily driven by their personal interests; they choose how much to work, with whom to work, and how many partners to have at any given moment. This leaves you with less freedom to negotiate additional contractor engagement like extra hours or exclusive work in your team. By shifting the contractor’s status to a full employee, you gain greater control over the working time of staff.
• Loyalty improvement. Contractors work on a freelance basis and shift partners very often. It is pretty rare to have really long-term arrangements with one business. That’s why a contractor typically feels loosely connected to the employing company and doesn’t participate in its corporate culture or contribute to its success. By hiring a person on a full-time basis, you make them a more loyal and committed part of the team and reduce the likelihood of their escape to competitors.
• Long-term business orientation. It is typical for startups to rely on contractor relationships, as they save on benefits, taxes, and pensions and engage the staff on a just-in-time basis. However, as the company grows and matures, it shifts to a long-term orientation and wants to have a core team of talented specialists dedicated to its success. At this stage, converting talented and qualified contractors into full-time staff is the best option, as it speeds up onboarding and guarantees the recruitment of people with proven credentials.

With all these points in mind, we recommend considering contractor-to-employee conversion only when you’re fully confident in the value of the team member for your long-term business objectives. You should reach a mutually satisfying full-time salary figure that won’t break the bank and will be perceived as fair compensation by the employee changing their status. Besides, the process should be adequately planned and executed in compliance with local jurisdiction.

In Which Cases Is It Profitable to Convert a Contractor Salary to an Employee Salary?

The contractor-to-employee conversion step is currently promoted as a beneficial solution for all kinds of businesses worrying about staff turnover, IP protection, and compliance. Indeed, converting contractors into full-time employees can be a great option in the following cases:

• Talent retention. The most common situation for contractor-to-employee conversion is the recognition of outstanding qualifications and talents in your temporary employee. If you see that a contractor has performed their duties to the fullest, and you need such talent on the team on a permanent basis, you can offer them a full-time job.
• Compliance management. Many companies fear misclassification fines and consider conversion before annual audits or other seasonal business checks. In such situations, spending a bit more money on employee benefits is much more profitable than facing a huge fine for non-compliance.
• Cultural integration. Contractors usually work as remote or temporary staff and have a loose connection with the corporate culture. Businesses that wish to achieve greater commitment, loyalty, and cultural fit in their staff may offer the conversion step to contractors, thus ensuring their closer engagement with the core business affairs.
• Control and supervision. Contractors are free riders whom you can hardly control in the process of completing their contractual obligations (unless some terms are laid out in the contract). For instance, they may work at night or over the weekends and engage with multiple clients at once. Thus, you can attain greater control and employee supervision only by hiring them full-time and fixing all their work duties in the employment contract.

Therefore, we recommend considering every conversion in a case-by-case manner so that you realize all potential gains and risks such a step will bring for your business. In the end, this decision is always an outcome of intricate cost-benefit analysis, as you will need to let go of some money and flexibility after converting a contractor into a full-time worker, and you will simultaneously get some perks from this move. You should always be aware of what you invest and what you get; otherwise, the process of conversion can turn into costly guesswork.