Tax Treatment of Statutory Employees
The term “common law” refers to a body of non-statutory tradition, custom, and decisions in actual cases that has historically been used as a basis for making legal decisions, often when laws and statutes governing the matter are unclear or do not exist. Under common law, someone who performs services generally may be considered an “employee” if the recipient of the services has the authority to control details of how the services are to be performed.
Statutory Employee vs. Independent Contractor
Generally, persons hired to do work when such control is not exercised, may be considered independent contractors under common law. Many factors may be considered in determining whether a worker is an employee or an independent contractor. One result of independent contractor status is that the employer does not have to withhold amounts from pay for federal tax purposes; independent contractors are obligated by law to fulfill these obligations on their own, usually through quarterly estimated tax payments.
There are certain types of workers who do not fall under the common law definition of employee and thus could be considered and treated as independent contractors. Statutes, for a variety of reasons, however, can dictate that such workers be treated as employees in certain respects, i.e., “statutory employees.”
This treatment includes that the person or entity that employs the workers must deduct federal employment taxes, such as Social Security, Medicare, and federal unemployment taxes (FUTA). The employer usually does not have to withhold amounts to cover income taxes. Failure to satisfy this withholding responsibility can lead to later payment of the taxes by the employer, plus interest and penalties.
Categories of Statutory Employees
A worker is a statutory employee if he or she falls under one of the following categories:
- A driver who distributes beverages (other than milk) or meat, vegetables or bakery products, or a driver who picks up and delivers laundry or dry cleaning, if the driver is the employer’s agent or is paid on commission.
- A full-time traveling or city salesperson who works for the employer and turns in orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar businesses. The orders must be for items sold for resale or use as supplies in the customer’s business. The work performed must be the statutory employee’s principal business activity.
- One who works at home on materials and goods supplied by the employer, which materials must be returned to the employer or to someone the employer designates, in conformance with employer specifications for the work.
- 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.
FUTA must be withheld for statutory employees in categories 1 and 2 above, but not categories 3 and 4.
Withholding Requirements for Statutory Employees
Pay for workers in any of these four categories is subject to Social Security and Medicare withholding if all of the following conditions apply:
- The service agreement states or implies that all, or substantially all of the services, are to be performed personally by the statutory employee;
- The statutory employee does not have a “substantial investment” in the equipment and property used to perform the services, other than a car or other mode of transportation; and
- The services are performed on a continuing basis for the same employer.
Categories of Statutory Non-Employees and Their Effects
The following are treated as self-employed for all federal tax purposes, including income and employment tax withholding:
- “Direct Sellers.” Persons engaged in selling, or soliciting the sale of, consumer products in the home or place of business, other than permanent retail establishments, or to any buyer on a “buy-sell,” a “deposit-commission,” or similar basis for resale in the home or at a place of business, other than a permanent retail establishment. This category also includes persons in the business of distributing or selling newspapers or shopping news, including related services.
- “Licensed real estate agents.” This category includes those engaged in appraisal for real estate sales, provided they earn income based on sales or other output.
The following conditions must also be met:
- Substantially all payments must be directly related to sales or other output, rather than the number of hours worked; and
- The service must be performed under a written contract that specified the statutory non-employee will not be treated as an employee for federal tax purposes.
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