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Learn about converting from contractor to employee

How to Convert a Worker from Contractor to Employee

At some point, you might need to convert an independent contractor to an employee.

You might have worked with a contractor several times, but now you want to hire them as an employee. For example, you might have used an independent contractor to periodically assist with your business’s marketing, but now you want to hire them as an employee who permanently works for you.

Or, you might have misclassified an employee. You labeled a worker as a contractor when you should have labeled them as an employee. If this happens, you need to convert them immediately.

Learn how to convert independent contractors to employees below.

Converting from contractor to employee

Use the following steps to convert your contractor to an employee.

Infographic: How to convert an independent contractor to an employee

1. Verify worker classification

First, you need to make sure that the contractor really should be an employee. Constantly switching a worker’s classification might give the IRS incentive to audit you.

To determine if a worker is a contractor or employee, use the IRS three-prong test. If you’re still not sure how to classify a worker, you can file Form SS-8 with the IRS. The IRS will send you a determination about how to classify your employee.

With contractors, you use the 1099-MISC form to report their wages. You do not withhold or contribute taxes on their wages. Instead, the contractors pay the taxes themselves.

With employees, you use Form W-2 to report their wages. You must withhold and contribute taxes on their wages.

Switching from contractor to employee means switching from Form 1099 to Form W-2.

Want to learn about worker misclassification? Download for free: A Guide to Independent Contractors vs. Employees.

2. Notify the worker

As soon as you decide to convert the contractor to an employee, notify the worker. Preferably, tell the worker in writing. A written memo is easier to track and document than a verbal message.

Document the date you notify the worker. If you mail the notification, obtain proof of mailing.

3. Gather employee information

You need to start an employee file and collect employment information to fill it.

For example, have the worker fill out Form W-4. This form will tell you the employee’s withholding allowances for federal income tax withholding. You and the employee should also fill out Form I-9, which verifies their eligibility to work in the U.S.

You should also add information about the employee’s pay to their file. This will include items like their rate of pay, whether they are hourly or salary, whether they are exempt or nonexempt, and their pay frequency.

4. Adjust payroll

You need to add your new employee to your payroll and time and attendance software.

Add the employee to your payroll so you can pay them properly and on time. You should enter their pay rate and pay frequency. If the employee should receive overtime wages, make sure you mark them as nonexempt.

Make sure the employee has access to your time clock, if you use one.

5. Treat the employee equally

You should treat the converted employee the same as any other employee.

If you give benefits to the rest of your employees, you should also offer benefits to this new employee. If you offer paid time off, this employee should receive it as well. Of course, you should follow your established policies.

6. Distribute Form W-2

You must give employees a Form W-2 after the end of each year. Form W-2 reports their wages for the year, along with how much of each tax you withheld from their wages.

Send the form to the employee by January 31. You must also send this form to the Social Security Administration.

Things to watch out for

If a contractor should really be an employee, you must convert them.

Converting from contractor to employee might cause the IRS to flag your business for an audit. If you’ve done nothing wrong, you have nothing to worry about. However, if you misclassified a worker as a contractor when they should have been an employee, there may be consequences.

Because you don’t pay taxes on contractor wages, you may owe taxes on the wages previously paid to the worker. You might also have to pay interest and penalties.

If you can provide a reasonable basis for treating the employee as a contractor, you might be able to avoid paying employment taxes. Publication 1976, Section 530 has more information.

You might also qualify to use the Voluntary Classification Settlement Program (VCSP). This program lets you reclassify workers with partial tax relief.

When you have employees, you need an efficient way to pay them. Patriot’s payroll software for small business is designed to save you time and money. Start your free trial today.

This is not intended as legal advice; for more information, please click here.

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