What Is a Statutory Employee
Erez Greenberg| Dec 11, 2022
Some professionals prefer to operate independently in business (think independent contractors), others opt for the full-time employee route. But for those who don’t land on either side, there’s a Goldilocks option and that’s a statutory employee.
The definition of a statutory employee is someone who is a combination of an independent contractor and a traditional employee. These workers are employees under federal tax law, but operate as independent contractors under common law.
A statutory employee is an independent contractor under common law rules, but considered an employee for tax withholding purposes.
Scroll down to learn what the status actually means, the tax implications of statutory employees, its pros and cons, and how to hire a statutory employee with little hassle.
First up, let’s see what employees need to achieve this status.
Who qualifies as a statutory employee
Though the IRS classifies statutory employees as independent contractors for standard laws, when it comes to taxes, statutory employees are treated as regular employees. To determine who earns the status of statutory employee, the IRS has four categories of independent contractors that get classified as statutory employees if they meet the following:
- Drivers who earn a commission distributing produce and meat, beverages aside from milk, bakery products, laundry or dry cleaning
- Full-time insurance reps selling life insurance or annuity contracts, mostly for one company
- Workers from home who get supplies from their employer and work based on specific instructions from the employer
- Full-time traveling salespeople who work with wholesalers, retailers, contractors, or hospitality businesses such as hotels and restaurants. This must be the salesperson’s main business.
Additionally, if an independent contractor meets one of the four categories described above as well as one of the three items below, businesses will need to withhold and pay Medicare and Social Security taxes:
- All of the services are performed by the independent contractor themselves (this needs to be included in the contract).
- They don’t invest in the equipment or materials they use for work
- They produce ongoing work for the same company
Just like regular workers, if an independent contractor meets these criteria, they’re classified as statutory employees. What does this mean regarding taxes?
Tax treatment for statutory employees
The IRS requires employers withhold taxes for Medicare and Social Security, just like they would with regular employees. If an independent contractor meets the statutory employee criteria, the employer will pay 7.65%, covering half of the Social Security and Medicare taxes.
Statutory employees will also fill out a W-2 form, checking the box that specifies their statutory employee status. These employees will also report their income and expenses on their Schedule C, just like independent contractors.
Before you file though, check your state’s legislation. California for instance, has specifications for unlicensed contractors and people in the entertainment industry to be considered statutory employees.
In general, a statutory employee will have more characteristics of an independent contractor than of an employee. The more benefits the employee is entitled to, the more likely they’ll have an employee status. Let’s drill down into the differences.
Employee vs a statutory employee
Most of the world’s workers are common law employees. To qualify as an employee:
- Common law employees receive an hourly or annual salary
- Employers decide on the job parameters and how the work gets done
- Employers are required to give employees the tools and technology needed for the role
- Employers must provide benefits including insurance, paid time off, vacation, and if applicable, employee discounts
- The employer has direct control over the financial aspects of the worker’s job (ie. how they’re paid, whether expenses are reimbursed, and who supplies the tools)
If an employer hires an employee, they need to fill out a W-4 form that dictates how much they’ll withhold from the employee’s pay to cover payroll taxes.
A statutory employee is classified differently. A statutory employee will receive a paycheck from the employer with a portion taken out for Medicare and Social Security, but they’re responsible for paying their own income tax every year. This means employers don’t need to withhold federal, state, or local income taxes.
A statutory employee will fill out a W-9 form, allowing them to deduct business expenses on their annual tax return, such as travel expenses, advertising, office expenses, and other write offs.
A statutory employee is somewhat of a mix between an employee and an independent contractor with a few differences. While both statutory employees and independent contractors need to cover their own benefits (or at least a portion) themselves, statutory employees don’t have the same control over their scope of work, hours, or ability to work for other businesses.
Here are a few other differences.
Independent contractors vs statutory employees
One of the main differences between statutory employees and independent contractors is that the latter can offer their skills and services to other companies. As they’re fully self-employed, they need to pay their own income tax on federal, state, and local government levels. All U.S. citizens for example, are taxed on worldwide salary and aren’t considered international contractors by the IRS.
Independent contractors need to pay self-employment tax (Social Security and Medicare) as well, though this’ll vary from country to country. In the United Kingdom, classifying as an independent contractor means you may pay corporate taxes rather than higher income tax and national insurance.
With these taxes though, come more work flexibility. Independent contractors can choose their hours, how they work, and who they work with. The only aspect employers can manage with independent contractors is when they’ll receive the final product.
Controlling the workload and how it gets done may partially explain why employers classify workers as employees instead of contractors. Let’s look at a few other reasons:
- Employees are more loyal – When employees only work for one company versus contracting out their services for several businesses, your business may not get as much of their attention. Employees who show up to work for the same company each day may feel more tied to its values and goals.
- Contractors usually work on short-term projects – if you have multiple projects occurring at the same time, multiple times a year, taking on statutory employees may make more sense for consistency.
- Contractors may cost more than employees – Depending on the contractor’s skills and experience, it might cost you more to hire a contractor than train an employee.
These very same reasons can also help you figure out whether the statutory employee route is right for your company.
Pros and cons of being a statutory employee
For some companies the benefits of onboarding a statutory employee outweigh some of the challenges. Here’s why this status appeals to many businesses.
- Employers can control workload – under this status, employers can still dictate hour, workload, and how the work is done.
- Employers save on cost of tools – Employers aren’t always responsible for providing statutory employees with all the tools and technology they need for the job. Employees will need to fill out a Schedule C to write off all business-related expenses.
- Avoiding misclassification- Just like other employees, statutory employees fill out a W-2 form each year, identifying themselves as a statutory employee by ticking box 13. This means they’re taxed correctly and businesses avoid misclassification.
One of the biggest playoffs for businesses when it comes to statutory employees is saving money on benefits and certain tax restrictions. But there are a couple disadvantages as well:
- Businesses can’t ensure consistency – statutory employees are responsible for equipment and supplies, which means business won’t have as much control over how the work is done
- Businesses need to pay benefits – compared to independent contractors where businesses don’t need to pay benefits, under a statutory employee status, businesses must contribute to Social Security and healthcare
Statutory employee statuses can benefit both employees and employers, especially when it comes to filing taxes. As we stated earlier on, Statutory employees need to fill out a W-2 form which, aside from preventing businesses from misclassifying employees, carries other significance as well.
What does statutory employee mean on a w2 form
Unlike an independent contractor, a statutory employee will still receive a W-2 at the end of the fiscal year. A statutory employee W-2 is slightly different from one for standard employees. This W-2 form has a box to mark the employee’s status as a statutory employee.
When employees fill out this type of W-2, they need to double check that they report their earnings on Schedule C, where they can also report other expenses such as work supplies.
Just as with filling out the W-2 form, hiring a statutory employee abroad isn’t that much different than taking on a regular employee.
How to hire statutory employees abroad
If you want to hire a statutory employee, you’d create a contract with employment and payment terms and negotiate with the worker. Though the process for paying these employees is slightly different than with a standard, full-time employee.
As an employer, you can pay statutory employees in various forms from commission, by product, or specific compensations. In addition, your company must obtain a W-9 instead of a W-4 and grant them several rights as an employee such as:
- A zero harassment or discrimination policy because of race, color, religion, sex (including pregnancy, sexual orientation, or gender), national origin, disability, age, or genetic information
- Equal pay for equal work
- Reasonable accommodations that are needed because of a medical condition or religious beliefs
- Keeping any medical or genetic information confidential
- Report discrimination, participate in a discrimination investigation or lawsuit, or oppose discrimination, without being retaliated against (punished) for doing so
No matter which type of employee you hire, you’ll want to pay attention to avoiding misclassification, which can have several ramifications from fines to employee deportation.
Here’s how to sidestep this common pitfall.
How to avoid employees misclassification
Any employee from statutory employee, independent contractor, common law employees, to non-statutory employees can be misclassified if the employer doesn’t fill out the right forms.
According to The Tax Advisor, to classify statutory employees, companies need to establish that the employee performs services for a service. Examples of statutory employees include:
- An agent-driver or commission-driver who distributes meat products, vegetable products, fruit products, bakery products, or beverages (besides than milk), or who picks up or delivers laundry or dry-cleaning
- A full-time insurance salesperson
- A home worker who performs work according to the employer’s specifications. The work product must be returned to the person or someone designated by him or her.
- A traveling or city salesperson, other than an agent-driver or commission-driver , engaged on a full-time basis on behalf of a principal of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments for merchandise for resale or supplies for use in their business.
From filling out W-2s to withholding taxes, Here you can learn more about workers misclassification.
Hiring your statutory employees with ease
Hiring globally doesn’t need to squeeze all of your time and resources. There are solutions that can help you manage hiring, onboarding, and payroll for any kind of employee, while you focus on more strategic tasks.
With local experts in over 160 countries, Papaya ensures you’ll never risk misclassification. From signing agreements with your contractors to managing payments, Papaya takes on liability and makes sure you’re covered with one click. To see our solution in action schedule a demo.
What are the state laws for hiring statutory employees?
Laws on statutory employees will vary from state to state. In California, state law mirrors federal law for determining who is a statutory employee, but also adds several types of work, such as an officer of a corporation, aside from the director. In other states such as New York, laws resemble federal guidelines for hiring statutory employees.
Do statutory employees receive W-2s before tax filing?
Statutory employees receive a W-2 when other employees do, at the end of January. All employees need W-2s to file their annual tax returns. Unlike other employees, though, statutory employees need to check off Box 13 on the W-2.
Do employers withhold income taxes from statutory employees' paychecks?
Like common law employees, a statutory employee receives a traditional paycheck from their employer with a portion of their income taken out to pay for Medicare tax and Social Security. Statutory employees aren’t subject to federal income tax being withheld from their paycheck, so they are responsible for paying their own income taxes every year.
Do statutory employees fill out W-4s?
Employees fill out W-2s and deduct work-related expenses on Schedule C as they file their annual tax returns. They must fill in Box 13 to be counted as a statutory employee. Companies hiring statutory employees will offer contracts, payment terms, and must fill out a W-9 instead of a W-4.