What Is a Statutory Employee

What Is a Statutory Employee? Everything you Need to Know

What are your obligations after hiring statutory employees in your business operation? 

Stefana Zaric
Written by Stefana Zaric
April 25, 2022
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A statutory employee is a mix of an independent contractor and a traditional employee. Specifically, it’s a worker that’s an employee under federal tax law but an independent contractor under common law. An individual who wants to be treated as a statutory employee must meet specific criteria defined by the IRS.

For many workers, being a statutory employee is the best of both employment arrangements:

  • They can keep a certain level of independence in their work
  • Their employer pays share of the statutory employee's payroll taxes via tax withholding, saving them from paying self-employment tax

Below, we explain what distinguishes statutory employees from traditional employees and self-employed independent contractors, the benefits of such employment status, and how taxes work for statutory employees.

What is a statutory employee?

A statutory employee is an independent contractor who’s treated as an employee for tax purposes. Specifically, statutory employees are independent contractors under common law rules but employees for federal tax purposes.

For such an arrangement to be possible, an independent contractor must meet specific criteria. The independent contractor must:

  • Be engaged with the same employer in a continuum for a more extended period
  • Deliver all the work specified in the contract independently
  • Not have made a substantial investment in the equipment they use to get the job done

As defined by the IRS, workers eligible to be statutory employees include:

  • Home workers who use supplies borrowed from an employer
  • Commission drivers delivering food (meat, vegetables, bakery products) and beverages (except milk), laundry, or dry cleaning
  • An individual working as a full-time life insurance sales agent for the same life insurance company
  • Full-time traveling salespeople or a city salesperson collecting orders from wholesalers, retailers, hotel and restaurant operators for the same employer
  • Insurance agents selling life insurance and annuity contracts on behalf of a company (selling company goods being the salesperson's principal business activity)

An additional category is ''statutory nonemployees.'' The IRS treats these workers like the inverse of statutory employees: they are employees under common law but considered contractors for federal income tax purposes.

Employee vs. statutory employee

The main differences between employees and statutory employees is how they perform the work, get paid, and control their working schedule.

According to the IRS, if you (an employer) determine what, when, and how your team members do their work, you must treat them as an employee (common-law employee).

On the other hand, statutory employees have more control over their working schedules. They follow their own schedule and usually do not work on the business’s premises, but might use gear borrowed from the employer. Still, to fall under the category of statutory employee, they must meet the criteria explained above.

Employees and statutory employees are treated equally for specific tax withholding purposes. For both categories, the employer must withhold income taxes to pay the employer's share of their FICA taxes (Medicare and Social Security taxes) and FUTA taxes (unemployment taxes).

Also, employers must file a W-2 form for both types of employees. Given that a statutory employee is still an independent contractor, they must also report their income and expenses on Schedule C. Regular employees, on the other hand, must report their income on a Form 1040 (Schedule A).

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Self-employed independent contractor vs. statutory employee

Unlike statutory employees who work for one company on a continuing basis, a self-employed independent contractor usually works for several clients on a project basis. In addition, statutory employees work with equipment borrowed from an employer, while self-employed independent contractors often invest and use their gear.

Employers withhold and pay the employer share of a statutory employee's Medicare and Social Security taxes, but they are not required to do that for a self-employed independent contractor. Instead, self-employed independent contractors must report their income and expenses using Schedule C and pay self-employed income taxes.

Note that every employer who pays over $600 to an independent contractor in a year must file a 1099-MISC form.

Employee misclassification leads to penalties

If you are satisfied with an independent contractor's or statutory employee's performance, you can offer to hire them as regular employees. However, regardless of their status, you must always correctly classify the people you work with.

Some employers try to avoid particular employee-related tax requirements by misclassifying employees and treating them as independent contractors. However, employee misclassification, when identified, can lead to severe penalties, even lawsuits.

If you have trouble classifying individuals you collaborate with, check out our guide on the tests employers use to determine whether they should treat workers as employees or independent contractors. You can also fill out Form SS-8 to request the IRS to help you make a determination.

Benefits of being a statutory employee

A statutory employee is the ideal combination of a traditional employee and an independent contractor. This type of employment partnership reserves a considerable level of autonomy and freedom with the tax benefits of traditional full-time employees.

Statutory employees get consistent full-time work

Being an independent contractor gives you more freedom, but without job security. Most independent contractors work on a project basis, so they constantly search for new clients and engagements.

On the other hand, a statutory employee is more secure because they work full-time for one client as their principal business activity.

Statutory employees receive employee benefits

According to the Affordable Care Act (ACA), employers with 50+ full-time employees must offer minimum essential coverage to every full-time employee. However, businesses with fewer full-time workers are not required to do so.

If a statutory employee works full-time, does that mean they are eligible for these? Not necessarily. Statutory employees aren’t guaranteed the same benefits as regular full-time employees by law, such as paid time off, retirement, or health insurance. However, many employers of statutory employees offer most, if not all, of these benefits.

Statutory employees participate in income tax withholding

One of the biggest benefits of being a statutory employee is that employers automatically take out some of the employee’s pay to cover income taxes. If the statutory employee were an independent contractor, they would have to set aside this money each month, quarter, or year to pay for independent contractors.

Statutory employees receive tax contributions from employers

Employers automatically pay the employer portion of a statutory employee's Social Security and Medicare taxes, known as FICA (Federal Insurance Contributions Act) taxes. If the statutory employee were an independent contractor, they would have to pay the employer portion as well as the employee portion. However, independent contractors can write off the employer’s contribution as a tax deduction.

Statutory employees can reimburse most business expenses

A statutory employee can deduct many business expenses by filing a Schedule C. Statutory employees use this form to report their income and costs such as travel, advertising, office expenses, and related expenses.

How do taxes work for statutory employees?

Statutory employees are not required to pay self-employment tax but must pay income tax. They also pay half of their FICA tax. An employer is another payer.

Below we answer the most common questions tax-related concerning statutory employees.

Do statutory employees fill out W-4s?

Some companies require a statutory employee to fill out a W-4: Employee's Withholding Certificate at the beginning of the working relationship. Other companies ask for Form W-9: Request for Taxpayer Identification Number and Certification. The latter comprises the employee's personal information and confirms their TIN (Taxpayer Identification Number) or SSN (Social Security Number).

Do employers withhold income taxes from statutory employees' paychecks?

No. Employers are not required to withhold statutory employees' income taxes. They are only required to withhold and pay FICA taxes.

Do employers contribute to certain taxes for employees?

Yes. Employers contribute to statutory employees' Medicare and Social Security taxes. These costs are split in half between an employer and a statutory employee. The 12.4% for Social Security contribution is divided, so both an employee and employer contribute 6.2%. It's the same as Medicare's total of 2.9% - an employer and employee contribute with 1.45% (IRS).

Do statutory employees receive W-2s before tax filing?

Yes. Like traditional employees, statutory employees receive a W-2 comprising details about their payments and Social Security and Medicare taxes withheld and paid. In addition, the statutory employees need this form to file annual tax returns.

State laws for statutory employees

Although the IRS has clarified what requirements an independent contractor must meet to be considered a statutory employee, some states, such as California, may have different or additional rules and conditions.

In California, aside from the four statutory employee categories listed above, the Unemployment Insurance Code includes additional occupations that permit an employee to be treated as a statutory employee. These include:

  • Film, radio, and television authors who meet specific requirements
  • An LLC (Limited Liability Company) member
  • A corporation officer (except the director)
  • An unlicensed contractor offering construction services that require a license

California employers are required to withhold certain employment taxes from a statutory employee's wages, including:

  • Medicare and Social Security Taxes
  • Employment Training Tax (ETT)
  • California unemployment insurance
  • State Disability Insurance

However, statutory employees in California are also entitled to benefits, such as:

  • ETT benefits
  • Paid Family Leave (PFL coverage)
  • Unemployment benefits
  • Protection from discrimination (FEHA)

Employee misclassification may also occur in California. For example, suppose an employee considers they should be treated as a statutory employee, not an independent contractor. In that case, they can turn to California’s Employment Development Department (EDD) and request a determination.

How to employ statutory employees overseas

If you consider hiring international employees, three options are at your disposal:

  • Open a foreign subsidiary
  • US visa sponsorship
  • Partner with an EOR (employer of record)

A foreign subsidiary, also known as a daughter company, is an independent entity that, once set up abroad, allows you to hire employees from that location. While the parent company owns it, a daughter company operates under its locations laws and tax regulations.

US visa sponsorship, or green card sponsorships, refers to a collaboration between an employer and the US government allowing a foreign employee to reside and work in the US as a nonimmigrant.

An EOR (employer of record), aka international PEO, hires employees from all around the globe on your behalf while taking care of global onboarding and payroll processes.

Hire statutory employees with Deel

Misclassifying workers can lead to lots of legal issues and financial consequences. Want to avoid dealing with trying to determine whether or not a team member is categorized correctly?

You can do just that with Deel. We ensure your contracts are compliant with local labor laws and handle the entire onboarding process for you.

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Disclaimer: this post is provided for informational purposes and should not be considered legal advice. Consult a legal professional and refer to official sources for more information.

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