Statutory Employees vs. Statutory Non-Employees

A statutory employee is a special type of worker whose wages are not subject to federal income tax withholding but are subject to FICA (Social Security and Medicare) and FUTA (unemployment) taxes.

To properly pay your workers and withhold necessary payroll taxes, you need to understand the IRS worker classifications:

• Independent contractor
• Employee (common-law employee)
• Statutory employee
• Statutory nonemployee

Most employers are fairly well-versed about what constitutes a self-employed independent contractor as opposed to an employee, but what about statutory employees and statutory non-employees? Let’s start with a brief review.

How Do Independent Contractors Differ from Employees?

Knowing how to determine whether a worker is an independent contractor or a common law employee is important because you generally must withhold income taxes, Social Security taxes, and Medicare taxes from wages you pay an employee. Employers have additional responsibilities surrounding employees, such as paying a portion of an employee’s Social Security and Medicare taxes and paying unemployment taxes (FUTA). Employers do not have to do any of this for independent contractors.

Under common law rules, whether or not a worker is an employee or an independent contractor is governed by the employer’s level of control. The employer must weigh factors in three areas:

• Behavioral: If the employer can direct or control how the worker does their work, that is a factor weighing for employee status.
• Financial: If the employer controls financial aspects of the worker’s job, such as how the worker is paid and whether business expenses are reimbursed, that argues for employee status. You will also want to consider who is providing tools and supplies the worker uses to perform the work. An independent contractor often makes a significant investment in the tools they use. Business employees generally do not.
• Type of relationship: Written contracts, employee benefits payments, the permanence of the working relationship, and whether the worker is performing services that are a key business activity all weigh toward an employer/employee relationship. A few examples of contracts and benefits are things like health insurance, pension plans, and vacation pay.

But you need to know more to properly pay a worker. You also must consider if your worker is a statutory employee or a statutory non-employee.

What Is a Statutory Employee?

Statutory employees are independent contractors under common law rules, but the employer must still withhold FICA (Social Security and Medicare) and pay FUTA (unemployment) taxes. However, the wages of statutory employees are not subject to federal income tax withholding. To be a statutory employee, a worker must fall into a specific category and meet conditions necessary to withhold Social Security and Medicare taxes. 

Categories of Statutory Employees

There are four categories of statutory employees:

• A driver who distributes beverages (but not milk), meat, fruit, vegetables, or baked goods. Also, drivers who deliver laundry or dry cleaning—if that driver is an agent or paid on commission.
• A full-time life insurance sales agent who sells life insurance or annuity contracts as their main business activity—and primarily for one life insurance company. These agents may use office space the employer offers them, but they do not pay for the use of stenographic assistance, telephones, forms, and similar resources.
• An individual who works at home on materials or goods that the company supplies. They must return these to the business or the person the business names after completing the work according to specifications.
• A full-time traveling or city salesperson. The work performed must be the salesperson’s prime business activity and be merchandise for resale or for use by the buyer in their business operations.

Withholding from Statutory Employees

FICA

It’s not enough that the worker just falls into the above categories. You should only withhold Social Security and Medicare taxes from the wages of statutory employees if they meet all three of these conditions:

• Their service contract says that substantially all the services they provide will be performed personally by the worker.
• They do not have a substantial investment in the equipment and materials they use to perform the services for you (transportation facilities are an exception).
• The worker performs the services for you on a continuing basis. 

In other words, if the worker has other individuals performing the service (an example might be a marketing or advertising agency) or if they themselves invest substantially in what they need to get the job done (anything from specialty software to heavy equipment) and the work is just a one-off or occasional work, they are not a statutory employee, and you do not need to withhold FICA taxes.

Income Tax

You should not withhold income tax from the wages of statutory employees.

What is a Statutory Non-Employee?

Categories of Statutory Non-Employees

There are three categories of statutory non-employees. They qualify as independent contractors and are not subject to federal income tax or FICA withholding under certain conditions. The three categories of statutory non-employees are:

• A direct seller or someone who markets and sells products directly to consumers away from a fixed retail spot. People who deliver and distribute newspapers and shopping news circulars are also clumped into this category
• A licensed retail agent.
• A companion sitter or someone similar to a caregiver who is qualified to prepare meals, do light housekeeping, and offer help with laundry and other errands for children or people who are disabled.

Withholding from Statutory Non-Employees

You should not withhold federal taxes for direct sellers or licensed real estate agents if

• Your payments to them are directly related to sales (or other output) rather than to the number of hours worked.
• You have a written contract with them that indicates you will not treat them as an employee for federal tax purposes.

Companion sitters who aren't employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes. However, in some cases, the companion sitter may be considered an employee for the person for whom they perform services, whether they perform work on a full-time basis or a part-time basis. If you control how work is done (not just what work is done), the worker is your employee, and you must withhold taxes.

Also, a household worker who is an independent contractor normally provides their own tools and offers their services to the general public. They don’t generally just work for you. See About Publication 926, Household Employer’s Tax Guide for more information and examples.