What is a statutory employee? Criteria & benefits

According to United States tax code, a statutory employee is a worker who is treated like an employee for tax withholding purposes despite being classified as an independent contractor under common law. This means the employer withholds their share of Social Security and Medicare taxes from their wages but doesn’t withhold income taxes. 

Drivers and delivery workers, salespeople, and remote workers (e.g., telecommuters, virtual assistants, and IT consultants) who operate on behalf of a company are commonly categorized as statutory employees. Unlike independent freelancers, these roles involve guidance and control by the employer, which may qualify them for certain benefits in order to maintain legal compliance. 

Statutory employee status can financially benefit employers and employees beyond simplifying payroll taxes. Statutory employees can claim tax deductions for business expenses, leading to lower taxable income and reduced tax liability. However, they accept increased risk and expenses due to a lack of employee benefits like paid time off (PTO), worker’s compensation, or a 401(k).

For employers, hiring workers as statutory employees simplifies tax withholding, streamlines payroll processes, and potentially reduces administrative costs. 

Who qualifies as a statutory employee?

To qualify as a statutory employee, an independent contractor must meet specific criteria and fall into one of four categories outlined by the Internal Revenue Service (IRS). Categories and criteria are outlined below:

Categories

1. Drivers who distribute meat and beverages other than milk, vegetables, fruit, bakery products, laundry, or dry cleaning and who earn a commission.
2. Full-time insurance salespeople who sell life insurance or annuity contracts, primarily for one life insurance company.
3. Home-based workers who use materials supplied by an employer to perform their duties.
4. 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.

Criteria

If an independent contractor performs one of the above roles, they must also meet these criteria to be considered a statutory employee:

• All of the services are performed substantially by the independent contractor themselves (this can be stated or implied in their contract).
• The contractor hasn’t substantially invested in the equipment or products they use to perform the work.
• They perform work on a continuing basis for the same company.

If an independent contractor doesn’t meet the above criteria, they may qualify as a non-employee. A non-employee provides labor but exercises more independence over the work structure and the terms of the employment agreement. Learn more about these categories and criteria on the IRS website.

How to hire and pay a statutory employee

Once you determine that a job role qualifies as a statutory employee, the hiring process is the same as hiring a regular employee. The hiring manager offers a contract that outlines the scope of work, compensation structure (such as hourly, commission, or fixed wage), and specific responsibilities and reporting requirements. Likewise, statutory employees must complete a W-9 form to confirm their personal information and taxpayer identification number. 

Statutory employees may be eligible for deductions on business expenses reimbursed by their employer, including travel costs, home office supplies, and professional services required to complete their job.

To maintain compliance, human resources and payroll should keep payment records, including hours worked, commissions earned, and expenses reimbursed. These will come in handy during IRS audits.

Statutory employees vs. independent contractors: How are they different?

Employers frequently conflate statutory employees and independent contractors. However, their work arrangements are significantly different. Here are four major differences:

1. Taxes: The employer covers half of a statutory employee’s Medicare and Social Security taxes (FICA taxes). Independent contractors pay self-employment tax and cover their own tax withholding and payments. 
2. Employers: Statutory employees typically work for a single company. Independent contractors offer their services to multiple clients. 
3. Autonomy: Companies that hire statutory employees exercise more control over when, where, and how their employees work, often setting deadlines and work hours. Independent contractors have autonomy over their workflow unless otherwise stipulated in a client agreement. 
4. Job roles: Insurance agents, traveling salespeople, and delivery drivers are typically categorized as statutory employees. Freelance writers, accountants, and building constructors are often independent contractors. 

Are statutory employees eligible for benefits?

Per IRS rules, a statutory employee is a hybrid between a regular employee and an independent contractor. Although employers are responsible for paying a portion of their statutory employee’s taxes, they aren’t required to offer the same benefits as regular employees. These might include sick leave, workers’ compensation, and a 401(k), among other benefits included in traditional compensation packages. 

For statutory employees, greater independence over their work comes with the responsibility of managing their own benefits and financial planning.

Does a statutory employee get a W-2?

Yes, employers are responsible for providing statutory employees with a W-2, checking off Box 13. A W-2 form is necessary for statutory employees to file their annual tax returns. Statutory employees don’t receive a 1099-MISC, which is meant for independent contractors.

Classifying workers correctly

Misclassifying an employee as a statutory employee can have severe legal and financial implications. The distinction between full-time employees, statutory employees, and independent contractors determines eligibility for various benefits and protections under common law. 

Employers who misclassify workers might be liable for hefty fines, back wages for unpaid overtime or benefits, and other penalties from federal and state labor agencies. Misclassification can also lead to expensive legal disputes, audits, and serious damage to an employer’s reputation. 

To avoid any confusion, check out Oyster’s worker classification analyzer. This tool helps you assess the correct classification of your employees and contractors based on their control over work hours, contributions to the business, and tools used.

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