What Is a Statutory Employee? Criteria and Compliance Explained

When it comes to classifying workers, there’s more than meets the eye. Beyond the familiar categories of employees and independent contractors, there’s a third type you need to know: statutory employees.

These workers are unique because they’re technically considered independent contractors, but certain laws require you to treat them as employees for tax purposes. Understanding who qualifies as a statutory employee is essential for maintaining compliance and avoiding legal headaches.

In this article, we’ll review what a statutory employee is and how they differ from regular employees, independent contractors, and statutory nonemployees. We’ll also discuss how to determine if you have statutory employees in your workforce and how Mosey can help with your business compliance needs.

What’s the Difference Between Independent Contractors and Employees?

What sets employees and independent contractors apart? For starters, employees fall under the Fair Labor Standards Act (FLSA), which means you must pay them minimum wage and overtime, withhold payroll taxes, and often provide benefits like health insurance and paid time off.

Independent contractors, on the other hand, don’t enjoy these protections. They set their own hours, negotiate their pay, and cover their own taxes and expenses. While this sounds simple on paper, figuring out who’s who isn’t always black and white. The rules for classifying workers are complex and constantly changing.

What Is the Economic Reality Test?

In the past, many businesses relied on the ABC test, which examined three criteria to determine worker status. However, in 2024, the Department of Labor (DOL) switched things up by introducing a new “economic reality” test.

This test examines six factors:

Potential for Profit or Loss: Can the worker make more money based on their skills and decisions?
Investments: Does the worker invest their own money in equipment or supplies?
Relationship Length: Is this a short-term gig, or is there potential for a longer relationship?
Control: How much control does the employer have over the worker’s tasks and schedule?
Importance to the Business: Is the worker’s role crucial to the company’s operations?
Skills and Initiative: Does the worker have specialized skills, and do they take initiative?

Misclassifying workers can have serious consequences. You could face hefty fines, back taxes, and even lawsuits if you incorrectly label an employee as an independent contractor. Get it right from the start to avoid a costly mess.

What Are Statutory Employees?

Now that we’ve gone over the basics, it’s time to look at what statutory employees are. The IRS defines them as workers who might typically be seen as independent contractors, but due to specific rules, you need to treat them like employees for tax purposes. So, who exactly falls under this umbrella?

The IRS lays out four main categories for statutory employees:

Drivers: Think of workers who deliver beverages (not milk), meat, veggies, baked goods, or even laundry and dry cleaning.
Life Insurance Agents: Full-time agents who mainly sell life insurance or annuities for one specific company.
Home-Based Workers: These individuals work from home using materials or goods provided by their employer, who also sets the specifications for the work.
Traveling or City Salespeople:** Full-timers who solicit orders for merchandise or supplies from wholesalers, retailers, or establishments like hotels and restaurants.

However, states can have their own rules in addition to federal ones. Take California, for instance. They consider corporate officers, certain drivers, salespeople, and home-based workers to be statutory employees.

Next, let’s talk taxes. If you have statutory employees who aren’t corporate officers, you’ll need to withhold Social Security and Medicare taxes from their wages if certain conditions are met.

These conditions can include the worker being expected to personally perform the services, not having a substantial investment in the equipment they use, or working for the same payer on an ongoing basis.

Officers can sometimes be classified as statutory employees, too, especially in exempt organizations. In these cases, they’re considered employees because of specific laws, even if they wouldn’t typically fit the mold of an independent contractor.

As you can see, comprehending the details of statutory employees is vital. Getting it right will keep tax authorities happy and avoid potential legal trouble.

What Are Statutory Nonemployees?

While statutory employees might seem like independent contractors, you must treat them like employees for certain taxes, specifically Social Security and Medicare. However, another category often gets mixed up with statutory employees — statutory nonemployees.

Unlike statutory employees, statutory nonemployees are considered self-employed for all federal tax purposes. That means they’re responsible for their own income and employment taxes, and you don’t have to worry about withholding anything from their paychecks.

Who counts as a statutory nonemployee? The IRS breaks them down into three groups:

Direct Sellers: These are people who sell products or services directly to customers, often outside of a fixed retail location. Think Avon representatives, Mary Kay consultants, or those selling door-to-door cleaning products.
Licensed Real Estate Agents: As the name suggests, these are licensed professionals who help clients buy, sell, or rent properties.
Companion Sitters: These individuals provide care and companionship to children, the elderly, or people with disabilities.

As long as these workers meet certain criteria, like having a written contract stating they’re not employees or getting paid based on their sales and output rather than hours worked, they’re considered self-employed. That means you don’t have to withhold any federal taxes from their earnings, and they’re on their own when reporting and paying those taxes.

You might be wondering, “Why should I care about the difference between statutory employees and nonemployees?” Knowing which category a worker falls into is crucial for staying compliant with tax laws and avoiding surprises from the IRS.

What To Consider for Business Compliance

Correctly classifying your employees isn’t just a matter of following the rules. Rather, it represents protecting yourself and your company’s bottom line. Misclassifying workers can lead to serious headaches, including hefty fines, time-consuming lawsuits, and stress you don’t need.

Additionally, if your payroll records are a mess because of incorrect classifications, it can snowball into more significant problems later on. This can include budgeting nightmares, tax filing headaches, and even issues securing loans or funding when you need it most.

To ensure that you’re doing everything by the book, technology can be of great service. Compliance automation tools can take the confusion out of worker classification and reporting by helping you determine who’s an employee, an independent contractor, or a statutory employee.

With this information, you’ll save time and money — but first, you have to choose the right tool. Mosey is a compliance management platform that’s designed to take the guesswork out of payroll compliance. It automates tedious tasks while keeping you current on regulatory changes.

However, technology is only one part of the compliance equation. You should also do your part to stay informed of regulations, as laws can vary from state to state, and even federal rules can shift unexpectedly.

How To Determine If You Have Statutory Employees

While the IRS provides clear guidelines on who qualifies as a statutory employee, applying these rules to your specific workforce can be tricky.

Here are some additional tips to help you determine if you have statutory employees:

Review Your Contracts

If you have workers in one of the four IRS categories, carefully review their contracts. Do the contracts state or imply that they will personally perform the services? Do they have a significant investment in the equipment they use? Do they work for you on an ongoing basis? If you answer “yes” to these questions, they may be statutory employees.

Consult With an Expert

Consider consulting a legal or tax professional if you’re unsure about a worker’s classification. They can help you assess the situation and make an informed decision.

It’s essential that your employees are classified properly. If you’re unsure which route to take, look over your contracts or seek assistance from an expert.

Stay Compliant With Mosey

Statutory employees are a special type of worker. They might seem like independent contractors, but there are specific rules for how to treat them regarding taxes.

We’ve covered the four main categories defined by the IRS: certain drivers, life insurance agents, home-based workers, and traveling or city salespeople. Remember, states might have their own rules in addition to federal ones, so it’s important to stay in the know.

Additionally, staying compliant is key to avoiding pesky penalties and legal issues. Ensure you’re classifying your workers correctly, withholding the proper taxes, and keeping accurate records. Tools like Mosey can make compliance a whole lot smoother. Book a Mosey demo to learn more.

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