Roughly one in five Americans are contract workers or freelancers, meaning they earn income based on projects they take on, and pay their own taxes. Half of these workers rely exclusively on contract work as their main source of income, and a smaller number are what’s known as statutory employees.
What does statutory employee mean? To oversimplify things, a statutory employee is a freelancer who does enough work for a single company in certain industries that they become an honorary employee in the eyes of the IRS. They earn certain tax advantages while retaining the freedoms of working as a contractor.
This article will examine what it means to be a statutory employee. We’ll explain the benefits and disadvantages of this type of employment compared with working as an independent contractor and the tax implications that differentiate the two.
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Statutory employee meaning
A statutory employee is a type of independent contractor who is considered an employee for payroll tax purposes. As an independent contractor, they pay their own income taxes and don’t receive full-time employment perks, but they do benefit from employer contributions toward Social Security and Medicare.
Companies generally like to take advantage of contractors to keep their payroll costs down, but to prevent an employer from treating a contractor as though they’re a full-time employee, statutory employment rules were formed. This means that any contractor who meets certain criteria—such as being unable to choose when and where they perform the work they’re contracted to do—automatically qualifies them to be treated as an employee by statute or, in other words, a statutory employee.
Who qualifies as a statutory employee?
The IRS has a set of clearly defined rules about whether an independent contractor qualifies as a statutory employee. The independent contractor needs to fall into one of four types of employment: drivers delivering food, drinks, and laundry; life insurance sales agents working for a single company; people who work from home but use equipment borrowed from work; and traveling salespeople working for a sole employer.
The IRS description of these jobs is specific, carefully worded, and has some exceptions. For clarity, we’ll reproduce the official IRS guidance on which roles qualify for statutory employment here:
- A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent, or is paid on commission.
- A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.
- An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.
- A full-time traveling or city salesperson who works on your behalf and turns in orders to you 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. The work performed for you must be the salesperson’s principal business activity.
It’s not enough to just fall into one of these categories. To qualify as a statutory employee, an independent contractor must also meet certain other criteria. Namely, they must be unable to subcontract their work to somebody else, they must not generally use their own equipment and supplies, and they must perform most of their work for the same employer.
Here’s the exact phrasing from the IRS on these points:
- The service contract states or implies that substantially all the services are to be performed personally by them.
- 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.
Benefits of being a statutory employee
There are certain advantages to being classified as a statutory employee versus simply an independent contractor.
You have reduced tax obligations
The main benefit to being a statutory employee is an overall reduction in the amount of tax you pay. Social Security and Medicare taxes total 15.3 percent of net earnings, with 7.65 percent paid by the employee and 7.65 percent paid by the employer.
Because independent contractors are simultaneously both an employee and an employer, they must pay both sides of the equation, meaning they’re taxed the full 15.3 percent. On the other hand, a statutory employee only has to pay half this amount, as their employer covers the rest. The employer must also withhold a portion of the employee’s wages to pay for these taxes. This effectively gives a statutory employee a 7.65 percent pay increase over an independent contractor.
You can continue to claim your own expenses
Although a statutory employee receives the tax advantage of their company’s contribution toward Social Security and Medicare, the employer isn’t required to withhold any federal or state income taxes. Statutory employees are responsible for reporting their own income and paying their own taxes each year.
Just like an independent contractor, a statutory employee can deduct any reasonable business expenses they incur to reduce their tax liability even further, giving them the best of both worlds.
How to hire and pay a statutory employee
The process of hiring a statutory employee is pretty much the same as hiring a regular employee, meaning the employee will have some form of a contract outlining the scope of the work they do and how much and how often they’ll be compensated.
However, there’s a slight difference in how a statutory employee gets paid. Although wages can be paid out in any form, such as on an hourly basis or by the commission, taxes are treated differently, and the employer must withhold a smaller portion of the employee’s paycheck.
Unlike with full-time employees, tax withholding for a statutory employee will cover just their Social Security and Medicare contributions. The reporting and payment of state and federal income tax remain the employee’s responsibility.
Tax information related to statutory employees
Because a statutory employee doesn’t have a portion of their paycheck withheld for income tax, they will complete a W-9 form (Request for Taxpayer Identification Number) rather than the usual W-4 form (Employee’s Withholding Certificate).
Like other employees, they should fill out a W-2 form each year, rather than the 1099-MISC form completed by contractors, in which they can identify themselves as a statutory employee by ticking box 13. This will ensure they’re being correctly taxed.
Statutory employee examples
A statutory employee is an independent contractor who falls into one of four job categories and meets three working conditions laid out by the IRS. We’ve given the precise definitions of these jobs at the top of this article, but here are some brief examples of statutory employment.
- Delivery drivers. This includes anyone who distributes food and drinks—not including milk—or who delivers dry cleaning or laundry.
- Home workers. But only those who work with materials and equipment provided by an employer, and who work to an employer’s specification.
- Life insurance sales agents. These sales agents must work primarily for one company, including those who sell annuity contracts.
- Full-time traveling salespeople. This means anyone who works on behalf of a sole employer to sell goods and negotiate orders with wholesalers, retailers, hotels, and other businesses.
The common thread linking all of these types of jobs is that the statutory employee is either paid per commission or relies on a single employer for their supplies, equipment, and resources.
Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.