Employers who want to flex their workforce on a budget might find independent contractors appealing. They don’t have to pay tax on wages paid to these workers, nor provide them with benefits. The trade-off is sacrificing some control of when, where and how work is conducted.
Not everyone may be comfortable with giving a worker that much leeway and that’s ok because sometimes there’s another option – statutory employees. A cross between an employee and an independent contractor, statutory employees allow employers to maintain more control of the work being done, while still keeping employment-related costs down.
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What is a statutory employee?
A statutory employee is a someone who classifies as an independent contractor under common law rules, but is considered an employee for payroll tax purposes. Only certain types of workers may be treated in this manner. To be eligible, an individual must fill one of four predefined roles and meet all three conditions of statutory employment.
Who qualifies as a statutory employee?
The IRS statutory employee definition is limited to the following categories:
- Drivers who are an agent of the employer or paid on commission to distribute beverages other than milk, or meat, vegetables, fruit or bakery products. This category also includes drivers who pick up and deliver laundry or dry cleaning.
- Full-time life insurance sales agents who work primarily for one life insurance company selling life insurance or annuity contracts.
- Individuals who work from home on materials or goods supplied by the employer that must be returned to the employer or a person named by the employer. The employer also provides specifications for the work to be done.
- Full-time traveling or city sales people whose principal business activity is working on one employer’s behalf turning in orders from wholesalers, retailers, contractors, or operators of hotels, restaurants and other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation.
Conditions of statutory employment
Simply filling one of the four previously described roles does not automatically grant statutory employment status. All three of the following conditions must also be met:
- The employment contract states or implies that the statutory employee personally performs all services for the employer.
- The statutory employee does not have a substantial investment in the equipment or property used to perform the services (other than an investment in transportation facilities).
- The services are performed on a continuing basis for the same payer.
Statutory employees vs. independent contractors
Although seemingly similar, statutory employees and independent contractors are different in several ways.
| Statutory employees: | Independent contractors: |
|---|---|
| Pay only the employee portion of Social Security and Medicare taxes, which is withheld from their pay by their employers | Pay the employee and employer portions of Medicare and Social Security taxes, also called self-employment tax |
| Work primarily for one employer | Work for several clients, often at the same time |
| Use equipment or supplies provided by the employer | Bring their own tools and supplies to the job |
| Receive a Form W-2 at year’s end | Receive an annual Form 1099-NEC |
Hiring a statutory employee
Employers and statutory employees typically agree to a service contract before work begins. Certain terms of employment must be clearly stated or implied, as previously described.
Paying a statutory employee
Due to the nature of the work performed, it’s not uncommon for statutory employees to earn a commission. Such workers may also be paid wages or receive piece-rate pay.
How to withhold taxes for statutory employees
When payment is due, employers must withhold Federal Insurance Contribution Act (FICA) taxes from statutory employee compensation and pay an equal portion of the taxes themselves. Income taxes are another story. Statutory employees are responsible for paying and reporting those taxes on their own.
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Learn MoreFilling out a statutory employee W-2 form
Statutory employees receive an annual Form W-2, Wage and Tax Statement like any other employee, but with a few key differences. Employers must complete Box 13 and check off the “statutory employee” option. Additionally, the income tax withheld fields do not apply to statutory employees.
Statutory employees and simplified employee pensions (SEPs)?
Statutory employees typically don’t qualify for employer-sponsored benefits. However, if employers offer an SEP retirement savings plan and statutory employees meet the eligibility criteria, they may participate in it. To qualify, the statutory employee must be at least 21 years of age, have worked for the employer for three of the last five years and earned at least $600 in the prior calendar year.
Frequently asked questions about statutory employees
Are there tax benefits for statutory employees?
Being a statutory employee could be more tax advantageous compared to independent contractors. Employers and statutory employees split the FICA tax burden with each party paying an equal share of Medicare and Social Security tax dues. Independent contractors pay self-employment tax, which is equivalent to the combined FICA total.
In other ways, independent contractors and statutory employees share the same tax breaks. For instance, they both may be able to claim tax deductions for their business expenses via Schedule C.
Are statutory employees eligible for insurance benefits?
Employers generally don’t extend insurance benefits to anyone considered a statutory employee. Restricting eligibility to only common law employees helps employers fill certain roles, e.g., drivers, insurance sales agents, etc., without increasing their operating costs too much. However, some employers may ignore this rule of thumb and allow statutory employees to receive benefits as a means of attracting and retaining talent.
What is the difference between a statutory employee and a non-employee?
Employers withhold and pay FICA taxes on wages paid to statutory employees, but they must treat statutory non-employees as self-employed individuals for all federal tax purposes. There are three categories of statutory non-employees – direct sellers, licensed real estate agents and certain companion sitters who are not employees of a companion sitting service. Two additional conditions must be met for direct sellers and licenses real estate agents:
- All payments for their services are directly related to sales or other output, rather than to the number of hours worked
- Services are performed under a written contract that states they will not be treated as employees for federal tax withholding purposes
What is the difference between a common law employee and a statutory employee?
Under common law employment, the employer has full control of what work will be done and how it will be done. Statutory employees tend to have a greater degree of autonomy than common law employees, though usually less than an independent contractor. For instance, statutory employees do not have a substantial investment in the equipment or property necessary to perform their job, whereas independent contractors usually provide their own tools and supplies.
This guide is intended to be used as a starting point in analyzing the statutory employee meaning and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
