Most of the time, workers are generally placed into one of two categories: employees or independent contractors. But did you know there is actually a third type of employee, known as a statutory employee?
Fast facts about statutory employees
- Employers must withhold and pay federal income tax, Social Security, and Medicare from the wages of statutory employees
- In some instances, statutory employees may be eligible for unemployment insurance
- Employers do not have to provide benefits such as health insurance or paid time off to statutory employees
- Among the criteria used to determine if an individual is a statutory employee is how much control an individual’s employer has over their work
Though it’s an employee classification that sometimes flies under the radar of business owners, it can be a good idea to understand what they are and the type of work they perform. Even though they’re less common, there could come a time (and place) when they are important to your company’s needs. But what exactly is a statutory employee, and how can you tell if a worker qualifies as one?
In this guide for employers, we’ll define what a statutory employee is, discuss some tax considerations, and find out more about the types of roles they’re usually responsible for.
What is a statutory employee?
Simply put, a statutory employee is someone who, according to the Internal Revenue Service (IRS), is an employee for tax purposes but is considered an independent contractor by common law rules. A worker is classified as a statutory employee if they pay their half of Medicare and Social Security taxes (in addition to their employer).
Now that we understand more about what a statutory employee is, let’s find out about the different job categories that fall under this designation, according to Uncle Sam.
IRS qualifications for statutory employees
According to the IRS, there are four different categories of employees that may be defined as statutory. Here is a breakdown of each one:
- A driver who distributes goods such as beverages, vegetables, fruit, or bakery products, or someone who picks up and delivers laundry or dry cleaning. The driver must be your agent (he drives exclusively for you) and is usually paid on commission.
- A full-time life insurance sales agent whose primary business activity is selling life insurance or annuities for one insurance company.
- An individual who works at home on materials or goods supplied by your business and must be returned to your business when completed, provided that specifications are provided to the individual on how the work should be completed.
- A full-time traveling or city salesperson who works on the behalf of your company and obtains and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed by the traveling salesperson should be the person’s principal business activity.
So now that we have a better understanding of who qualifies as a statutory employee according to the IRS, let’s see how the specifics match up with one of the more common types of workers that employers come across.
What is the difference between a statutory employee and an independent contractor?
As a general rule, independent contractors perform a job for multiple companies, while a statutory employee works independently for a single company. This area can become a little confusing to some employers who may not know exactly how to classify a worker, but one simple way to clear up any misunderstanding is to answer this question:
Does the worker only perform duties for my company, or do they perform the same duties for multiple companies?
- If they only work for you, they should be considered a statutory employee.
- If they contract with several businesses, they would be considered an independent contractor.
Another thing to consider is how much control you exercise over a worker.
For instance, do you determine how the work gets completed and when it should be done, or does the worker set their own schedule?
If all of this talk about worker classification is making your head spin, there may be some changes on the horizon to keep an eye out for. Specifically, the U.S. Department of Labor (DOL) is looking into methods that might make it easier to determine whether a worker is an employee or an independent contractor, but the regulations have been temporarily put on hold until a special review has been completed. That said, as more information becomes available from the DOL, we’ll add the updates to this article. For now you an read some of the proposed rules on the Office of the Federal Register, which was posted in October 2022.
Are there specific requirements to be classified as a statutory employee?
Again, according to the IRS, three conditions must apply for an employee to be considered statutory:
- All services must be performed by the employee
- The employee does not have a substantial investment in the equipment and property used to perform services.
- The services are performed on a regular basis for the same employer.
If these three conditions are not met, the worker should be classified differently.
What are some common examples of statutory employees?
Though we spelled out some specific criteria (and broader job descriptions defined by the IRS), how can you be sure exactly what statutory employees are or whether any of your employees would qualify? Here are a few examples.
Insurance salesperson
- In most cases, an insurance agent selling life insurance and annuities is considered a statutory employee. If their primary responsibilities include selling insurance for your company, they are a statutory employee (regardless of whether they use your office to perform duties or have their own).
Traveling salesperson
- A salesperson who works on your behalf (for example, soliciting and submitting orders from retailers, wholesalers, hotels, and other businesses) is often considered to be a statutory employee — as long as the orders are strictly for your business. On the other hand, the salesperson would be considered an independent contractor if they are selling or soliciting orders on behalf of more than one company.
Driver
- Do you have a driver that distributes beverages or other products to multiple retail outlets and they are considered your agent and/or are paid on commission? This is another example of an individual that would be considered a statutory employee.
Piece workers
- If you provide an employee with goods and materials to assemble or otherwise complete at home — to be returned to you upon completion — they would be considered a statutory employee.
Now that we’ve gone over some specific examples, let’s take a closer look at how withholding works for statutory employees.
Taxes and statutory employees
Working with statutory employees can make tax withholding a little more complex, but here are some points to keep in mind.
- If you hire someone and classify them as a statutory employee, you will need to withhold and pay the employer part of Social Security and Medicare taxes (FICA) for them.
- However, you are not required to withhold any federal or state taxes from their payment.
- The first to do when hiring a statutory employee is have them complete Form W-9: Request for Taxpayer Identification Number and Certification instead of Form W-4: Employee’s Withholding Certificate (which your regular employees are required to fill out.) The reason why is that you are not responsible for withholding any federal or state income tax, but you’ll still need their Social Security number for year-end filings.
- When setting up payroll, make sure that you only withhold FICA taxes and that when paying taxes, you include both withholding and your portion of FICA for all statutory employees.
W-2’s and statutory employees
Finally, at year-end, you must provide any statutory employees you worked with a W-2 and keep in mind that “Box 13 – Statutory Employee” needs to be checked off.
The W-2 should include the total amount of wages paid to the statutory employee as well as the amount of Social Security and Medicare taxes withheld for the year. Remember that sending your statutory employees a 1099-NEC, which is the form that independent contractors receive, is not required.
Are there tax benefits for statutory employees?
Statutory employees are eligible to receive a couple of tax benefits. For example. they are allowed to file Schedule C so they’re able to deduct eligible expenses such as travel, advertising, and office expenses related to their job that they could not deduct if they were an employee.
Another advantage is that as a statutory employee, they only need to pay half of the FICA taxes due. If they were an independent contractor, they would be responsible for both the employer and employee portion of FICA.
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Did you know?
Keep in mind that it is not necessary to send a 1099-NEC — the form that independent contractors receive — to your statutory employees.
Are statutory employees eligible for insurance benefits?
While there are some tax benefits statutory employees can take advantage of, generally they are not eligible for any of the benefits received by regular employees including:
- Health insurance
- Vacation and paid time off (PTO)
- Retirement contributions
That being said, statutory employees are eligible to contribute to a Simplified Employee Pension Plan or SEP, if an employer offers it.
Certain situations call for statutory employees
Depending on the nature of your business or the type of services you offer, hiring statutory employees (and understanding the trickier aspects of working with them) might not be an item you need to have on your “to-do” list. Though the chances may be slim, if you come across a scenario where hiring a statutory employee is the right fit to perform a certain task or work for your business, it’s important to have the correct processes in place to manage statutory employees properly.
This article is provided for informational purposes only and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors for formal consultation.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.