Statutory employees

What is a statutory employee?

A statutory employee is an independent contractor under common law but, for certain tax-withholding purposes, is treated as an employee. When hiring a statutory employee, employers are not required to withhold a statutory employee’s income taxes. However, employers do withhold Social Security and Medicare taxes if specific conditions apply. Certain statutory employees are also subject to Federal unemployment (FUTA) tax.

According to the IRS, an employer must withhold Social Security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply:

• The service contract states or implies that they substantially perform all the services personally.
• They do not have a substantial investment in the equipment and 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.

Who is considered a statutory employee for exempt organizations?

For an exempt organization, an officer such as a president, vice president, secretary, treasurer, or chief executive officer can be a statutory employee, according to the IRS. This classification is because some workers are deemed to be employees by statute.

What is the common law test?

The common law test is a guide the IRS uses to determine if a worker should be classified as an employee or independent contractor. It involves a great degree of subjectivity, and judgment is required when weighing all the facts and circumstances. 

The IRS states, “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.”

When applying the common law test, the primary consideration is determining who has the right to control the work that must be done and how it must be done. If an employer has the right to exercise control over when, where, and how a job is performed, it typically means the worker should be classified as an employee.

As outlined by the IRS, the facts that provide evidence of the degree of control and independence generally fall into three categories:

1. Behavioral. This refers to whether there is a right to direct how workers perform the work and involves such factors as training, the degree of instructions, and the type of instructions given. 
2. Financial. This refers to whether or not the business has the right to govern the economic aspects of the worker’s job — like how the worker gets paid, whether they are reimbursed for expenses, if the worker provides their own tools and supplies, etc.
3. Type of relationship. This refers to how the worker and business perceive their relationship to each other. Are there written contracts or employee-type benefits like insurance, vacation pay, etc.? Will the relationship continue, and is the work performed a key aspect of the business?

It is critical that business owners correctly classify employees. If an employer incorrectly classifies an employee as an independent contractor and they have no reasonable basis for doing so, the employer may be held liable for employment taxes for that worker.

What are the categories of statutory employees?

A worker is a statutory employee if they fall under one of the following categories, according to the IRS:

• Specific drivers. This applies to a worker who delivers meat, vegetables, fruit, bakery products, or beverages other than milk. It also applies to someone who picks up and delivers laundry or dry cleaning if the driver is an employer’s agent or gets paid on commission.
• Certain insurance sales agents. This refers to a full-time life insurance sales agent whose principal business activity is selling life insurance, annuity contracts, or both. The worker typically sells the contracts for one life insurance company.
• Select home workers. This applies to an individual who works from home on materials or goods that the employer supplies. These materials or goods must be returned to the employer or a person the employer names. The employer must also furnish specifications for the work to be done.
• Full-time traveling or city salesperson. This is a salesperson who works on the employer’s behalf and turns in, to the employer, orders 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. In addition, the work performed for the employer must be the salesperson's principal business activity.

What is the difference between a statutory employee and an independent contractor?

There are several significant differences between a statutory employee and an independent contractor despite the fact that, at first glance, the two classifications may seem similar:

• Social Security and Medicare taxes. For statutory employees, employers must withhold the employee’s portion of the Medicare and Social Security taxes. The employer does not withhold any Medicare and Social Security taxes for independent contractors.
• Tax forms. At the end of the year, employers must furnish statutory employees with a Form W-2. Employers furnish independent contractors with a Form 1099-NEC.
• Equipment and supplies. Statutory employees will perform the job using equipment and supplies provided by the employer. Independent contractors will use their own equipment and supplies to complete a job.
• Employers. Statutory employees perform work for primarily one employer. Independent contractors are usually working for several clients simultaneously.