Statutory Employee Definition
A statutory employee is an independent contractor who is treated as an employee for employment tax purposes. These workers meet the criteria for an independent contractor, but the IRS has decided that by statute they need to be treated as an employee when it comes to employment taxes specifically.
When you’re finally ready to hire workers, you may find yourself faced with this question: Should you hire employees or independent contractors?
But, because the IRS likes to keep things interesting, they have another classification that your workers can fall into: statutory employee. These independent contractors are treated as employees for a few very specific tax purposes.
While adding another type of worker classification can be confusing, this guide will explain who qualifies as a statutory employee and how you need to treat their taxes differently.
What Is a Statutory Employee?
A statutory employee is an independent contractor who is treated as an employee for employment tax purposes. Think of it as a hybrid between an employee and an independent contractor. These workers meet the criteria for an independent contractor, but the IRS has decided that by statute they need to be treated as an employee when it comes to employment taxes.
Who Is Considered a Statutory Employee?
While there are a lot of independent contractors—people who do work for a company without being an actual employee—the criteria for them to be classified as a statutory employee is very narrow. The IRS defines four categories of independent contractors that are included in the category of statutory employees. If an independent contractor falls into one of these categories and meets three additional criteria, you’ll need to treat them as an employee for certain employment taxes (Medicare and social security taxes).
The four categories of independent contractors that should be considered statutory employees, as defined by the IRS, are:
- Drivers who distribute beverages other than milk, meat, vegetables, fruit, bakery products, laundry or dry cleaning and who earn a commission.
- Full-time insurance salespeople who sell life insurance or annuity contracts, primarily for one life insurance company.
- Home-based workers who use materials supplied by an employer and work on them based on specifications provided by the employer.
- Full-time traveling salespeople who solicit orders from wholesalers, retailers, contractors, or operators of hotels or restaurants. The orders must be used for sales in their business operations and this must be the salesperson’s principal business activity.
If an independent contractor falls into one of the four categories above and meets the three criteria below, you’ll need to withhold and pay Medicare and social security taxes, as you would for an employee.
- Substantially all of the services are performed by the independent contractor themselves (this can be stated or implied in their contract).
- They haven’t invested substantially in the equipment or products they use to perform the work.
- They perform work on a continuing basis for the same company.
Tax Treatment for Statutory Employees
The IRS requires that statutory employees be treated as employees when it comes to Medicare and social security taxes. What does this mean?
Because companies don’t withhold taxes, provide benefits to, or pay Medicare or social security taxes for independent contractors, they are able to save a lot of money. The independent contractor essentially pays twice as much in social security and Medicare taxes as an employee because they are on the hook for paying the portion that an employer would pay.
When someone is an employee, the employee and employer are jointly responsible for paying Medicare and social security tax. They are also responsible for paying other federal, state, and local payroll taxes. Of these taxes, 15.3% is made up of social security tax (12.4%) and Medicare tax (2.9%). But because the employee and employer split the burden, each side pays 6.2% for social security tax and 1.45% for Medicare tax. The employer withholds the employee portion from their paycheck and pays the matching amount.
A self-employed person is required to pay self-employment taxes. These are the full Medicare and social security taxes of 15.3%—there’s no company chipping in. Half of the tax is considered the employer-equivalent portion of the tax (what your employer would pay if you were an employee), and can be taken as a deduction.
When an independent contractor is considered a statutory employee, the employer needs to pay the 7.65% to cover their half of the social security and Medicare taxes.
Independent Contractor, Employee, or Statutory Employee
When you run a business, there are a few different ways people who perform work for you can be classified. Determining whether someone is an employee or an independent contractor or a statutory employee can be complicated and it’s important to take the time to get it right.
There are a number of criteria that are used to determine whether a worker is an employee or an independent contractor. In general, a worker is considered an independent contractor if you only control what the end result is and not how it is done. If an employer controls what will be done and how it gets done, the worker is likely going to be considered an employee.
For example, a freelance graphic designer who uses all their own equipment and decides when and where they’ll work would be considered an independent contractor.
An independent contractor reports their income and related expenses on Schedule C.
- Withholding: For most independent contractors, you don’t withhold or pay taxes. The independent contractor is responsible for paying self-employment taxes.
- Tax form: If you made payments of more than $600 to an independent contractor during the year, you’ll need to file Form 1099-MISC.
The IRS states that anyone who does work for you should be considered an employee if “you control what will be done and how it will be done.” With an employee, you are required to withhold income taxes, withhold and pay Medicare and social security taxes, and pay unemployment taxes.
If the graphic designer (above) reports to their employer’s office every day, uses equipment provided by the employer, and doesn’t control their own schedule, they are going to be considered an employee.
It may be tempting to try and treat employees as independent contractors to minimize the taxes that you pay as well as what you need to withhold. But misclassifying an employee as an independent contractor can be a costly mistake. The IRS provides more guidance on how to make the determination as well as Form SS-8, which you can file with the IRS to get their decision on whether your worker is an independent contractor or an employee.
Employees will report their income on Form 1040. They can’t deduct expenses—even non-reimbursed expenses that relate to their job.
- Withholding: For most employees, you (the employer) must withhold and pay the employer portion of social security and Medicare taxes, as well as federal, state, and local income taxes.
- Tax form: Each employee should receive a W-2 form.
A statutory employee is an independent contractor who falls within a narrow definition set by the IRS, as we described above. For example, a full-time life insurance salesperson who primarily works for one company on an ongoing basis, and hasn’t invested much into the equipment they use, will be considered a statutory employee.
The company paying this salesperson will need to also pay the employer portion of their Medicare and social security taxes.
Statutory employees will need to receive a W-2 form with the box ticked showing that they are a statutory employee. They’ll then report their income and expenses on their Schedule C, just as a normal independent contractor would.
- Withholding: For statutory employees, you must withhold and pay the employer portion of social security and Medicare taxes.
- Tax form: Statutory employees should receive a W-2 form, detailing payments made to them as well as Medicare and social security taxes that were withheld and paid.
While the IRS lays out exactly who they consider a statutory employee, before you take that as the final word, you’ll want to check with your state. They may have other rules and requirements that you need to consider.
For example, California adds additional guidelines for unlicensed contractors and people in the entertainment industry to be considered statutory employees.
A CPA or lawyer can help you understand if there are additional requirements for your state.
The Bottom Line
When you hire workers, there are a lot of different rules and situations that you need to take into consideration. Understanding the difference between an employee, an independent contractor, and a statutory employee is a great place to start. Before you make your final decision, it’s always best to speak with an attorney and tax professional to ensure you’re classifying your workers correctly.