Statutory Employee: Everything You Need to Know
A statutory employee is someone who is not quite a common law employee or an independent contractor, but the fall somewhere in between those two types of workers.8 min read
2. Statutory Employees and Everything to do with Hiring Them, Paying Them, and Addressing Their Taxes
What is a Statutory Employee?
A statutory employee is someone who is not quite a common law employee (somebody legally employed by a business) or an independent contractor (somebody who is self-employed and provides products or services to various clients), but the fall somewhere in between those two types of workers. When a statutory employee works for a business, the business owner does not have to withhold taxes from on their wages. Employers do, however, need to withhold these employee’s Medicare and Social Security tax. Instead of deducting expenses on Schedule A, a statutory employee will deduct their expenses on Schedule C. Examples of statutory employees include specific home workers, traveling salesmen, commission drivers/agent drivers, and insurance salesmen.
What makes someone a statutory employee depends on several different factors. Of the many factors that there are, the most influence one is the level of control that the worker’s employer has over their work. Typically, there are two primary types of working people that the public knows about: employed and self—employed. There are pros and cons associated with each one. A self-employed professional can use Form 1040, Schedule C, Profit or Loss from Business to save on taxes by deducting legitimate business expenses. The downside to self-employment is the need to file self-employment tax. A benefit of being employed is that the worker only has to pay half of Medicare and Social Security taxes while the employer pays the remainder. And the downside to being employed is that employees can’t deduct expenses against their income.
As you can see, self-employed individuals and employees have unique advantages and disadvantages, but there is another kind of worker who can get the best that each category has to offer: the statutory employee. A statutory employee is similar to an independent contractor, but a statutory employee doesn’t have to invest in the same start-up capital that an independent contractor might (such as buying or renting a facility to work out of, purchasing equipment, and investing in office supplies). Whether or not someone is a statutory employee depends on a variety of factors, primarily the following:
- A statutory employee is able to deduct their business expenses against their income on Schedule C, just like independent contractors.
- But just like employed individuals, statutory employees only have to pay half of their Medicare and Social Security taxes since their employer is paying the other half.
- Even though a statutory employee is not a self-employed individual, they do need to file a Form 1040, Schedule C.
- Statutory employees also have to fill out a W-2 form and check box 13 for Statutory Employee. According to Rev. Rul. 90-93, it is imperative to understand that a statutory employee is not a common law employee. This needs to be known for the section of the W-R that addressed adjusted gross income (Sec.62) and 2% of itemized deduction (Sec. 67)
- At this time there aren’t any statistics that provide information on just how many people file as statutory employees when doing their taxes.
- The IRS (Internal Revenue Code) doesn’t actually use the term “statutory employee”. This term is, however, defined in Sec. 3121(d)(c). In this portion of the document, it provides details on what provisions an eligible statutory employee can benefit from.
- Someone like a commission-driver or an agent-driver who deliver bakery products, meat products, fruit products, drink products, or vegetable products could be classified as a statutory employee. This person is also referred to as a person how performs services for remuneration. Other examples include a person who delivers dry-cleaning or a full-time insurance salesperson.
- When an employer hires a statutory employee, both parties need to agree to and sign a service contract. On the service contract, there should be a detailed list of all of the services the statutory employee will perform on their own. Keep in mind that somebody who has facilities that they obtained through their own financial investments (such as a photography studio that they set up themselves, pay rent for, and furnished with photography equipment) is not a statutory employee; this is an independent contractor and should be treated as such. If you want to learn more about how a worker’s investment in facilities and how that means the person an independent contractor, take a look at A General Counsel Memorandum for a more comprehensive overview of these regulations.
- The person acting as the statutory employee is permitted to use their own vehicle to travel for work purposes or to perform their services.
- A full-time life insurance salesperson is an example of a statutory employee. For the most part, they will work a part of their time out of an office space headquartered at their employer’s facility. They will do some administrative tasks and use the company’s office supplies to do that without incurring any costs themselves. However, they will also spend the majority of their time out “in the field” selling life insurance and traveling from business to business or city to city to do so.
- There are two specific incidences when a full-time life insurance salesperson might not be considered a statutory employee for two reasons: 1) the service contract does not explicitly state that the individual will perform insurance services solely for one company and 3) only a portion of their work time is spent selling life insurance.
One of the toughest issues with defining a statutory employee and determining what qualifies as a statutory employee is that said individual falls somewhere in between the common law employee and the independent contractor. However, the statutory employee is probably closer to the independent contract in terms of definition. Basically, statutory employees and independent contracts have more traits in common than a statutory employee and a common law employee do.
According to the Tax Court, what determines statutory employee status has a lot to do with intent (intent of both the worker and the employer). One way intent can be determined is if the employer checks the statutory employee box on the W-2 form. Additionally, the Tax Court will review the employee and take notes on whether or not he or she receives such benefits as health insurance, vacations, sick leave, and a 401(k) plan from the employer. It is generally the case that the more benefits the worker receives, the most likely it is that they are a common law employee. According to regulations, “In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor.”
The Tax Court provides a list of seven basic factors that can help a person determine whether or not they are a statutory employee, common law employee, or an independent contractor
- How much control is granted to and exercised by the principal (the person employee the worker).
- Whether or not it is the employer or the worker who makes a financial investment in the working facilities that the worker will commonly use.
- How much opportunity the worker has for profit and loss.
- Whether or not the principal (also known as the employer) has the power to discharge or fire the worker.
- If the work involved is a crucial component of the employer’s business operations.
- How permanent the relationship between the employer and the worker is.
- What kind of relationship the employer and the worker planned and agreed upon in the beginning.
During a review by the Tax Court, all of these factors are examined and there is just one factor alone that could determine the status of a worker. One of the first things the Tax Court will look at is the level of control exercised by the employer. With that said, it is important to note that just because a worker might not be managed heavily by a supervisor doesn’t automatically mean they aren’t an employee. For example, a manager doesn’t have to watch a worker’s every move, every minute of every hours of the day and that worker could still be considered a common law employee.
Another big factor that separates statutory employees from independent contractors is that the statutory employee does not work out of their own facility or supply their own materials to do their work. The only thing they might work with that is their own is their personal vehicle. If you look at Rev. Rul. 87-41, item 14, you will find the full list of materials that would prove a person is an independent contractor.
Many employers sometimes want an employer of theirs to work from home so that they are able to classify those employees as independent contractor. Talk to any legal expert or tax professional and they will tell you that the only way you could legally convert your employee into an independent contractor who works from home is if you do not supply them with any of the material needed to do their job. In a situation like this, it would be better to try to obtain statutory employee status for the worker rather than independent contractor status. This way, the employer can still cut down on some overhead expenses by sending their employees to work at home, yet stay out of legal trouble when they need to send their statutory employee working supplies and other materials.
- As the employer, you are not required to pay FUTA or withhold income tax.
- If you are having some trouble persuading your employee to work from home, remind them that as a statutory employee who works from home, they will be allowed to deduct their expenses again their income.
Statutory Employees and Everything to do with Hiring Them, Paying Them, and Addressing Their Taxes
When it comes to taxes, although the statutory employee is treated as an individual separate from the company, they are still taxed the same way a common law employee might be. Under current IRS classifications, there only but four categories that make up statutory employees:
- Certain kinds of drivers
- A Full-time salesperson (specifically someone who spends the bulk of their time traveling from city to city)
- A full-time life insurance sales agent
- A person who works from home but is supplies with your company’s materials to complete the work
In addition to statutory employees, there are also statutory nonemployees, according to the IRS. Only thee kind of workers fall under the category of statutory nonemployees:
- Specific types of companion sitters
- Direct sellers
- Licensed real estate agents
When someone qualifies for statutory employee status, the tax requirements might seem confusing and overwhelming at first. As a statutory employee you have to pay your own income taxes while your employee pays half of your FICA taxes. All of the tax information should be included in a service contract for you to read over and become familiar with before signing the agreement. Because a statutory employee pays incomes taxes themselves, they don’t file a W-4 form; instead they have to file a W-9 form. The way statutory employees are paid also varies with each situation. Workers like salespeople and agents are often receive commission pay. Someone who works on one piece (such as one specific, unique product or service that doesn’t already exist) at time might be paid a flat rate for each piece.
Are you in need of additional information related to statutory employee status, pay rate, taxes, procedures, and legalities? Or are you uncertain of whether or not you are a statutory employee yourself and want answers from the legal experts regarding how to do your taxes? Don’t hesitate to post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.