If you're reading this, odds are that you have a job. In fact the numbers suggest that you're probably reading this article at work. (Well done. TheStreet is an outstanding choice for your coffee break.)
But there are a lot of ways to have a job. Most people are employed, otherwise known as "W-2 workers," and their employer withholds taxes from each paycheck. If that work is full time, the employer also pays benefits. If that work is part time, meaning they work less than 30 hours per week, the employers don't have to provide benefits.
Approximately one in five Americans work as "contract" workers, which means that they earn money per unit of work done and pay their taxes themselves. A little more than 10% of Americans rely exclusively on contract and freelance work for their incomes. Then there are statutory employees.
They are a different category altogether.
What Is a Statutory Employee?
A statutory employee is a contract worker treated as an employee for payroll tax purposes. To understand this, we need to look a little further at the nature of contract work.
What Is a Contract Worker?
A contract worker is someone who does work for a business but who isn't hired as an employee. The business hires the contract worker to perform a specific service in exchange for a specific payment. This is as opposed to an employee, who is hired to do a job for either a salary or an hourly rate.
Contractors pay all of their own taxes and do not receive benefits. The employer doesn't withhold either income tax or payroll taxes and doesn't pay the employer's share of the contractor's payroll taxes. This leads to what is known as the "self-employment tax," a functional 7.65% tax increase on freelancers, contractors and small business owners because they pay twice as much in payroll taxes as everyone else.
Many employers like to rely on contractors to save money, however, there are strict rules about classifying workers as contractors vs. employees. As the IRS points out in its guidance on the subject, "[t]he general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done." If someone has a boss, expected working hours and can't freely seek additional work, they are probably an employee and entitled to benefits and tax advantages.
What Is a Statutory Worker?
A statutory employee falls in between an employee and a contract worker. An employer treats them as a contract worker for income tax purposes, meaning that the worker still pays their own income taxes.
However, the employer does have to treat the worker as an employee for payroll tax purposes (FICA taxes). This means that the employer must withhold payroll tax and pay the employee's share. This is a significant advantage over contract work.
Who Is a Statutory Employee?
The IRS identifies four categories of worker who can be considered a statutory employee. Here we will use the exact language from the agency's publication as word choice is critical when understanding an IRS guidance:
• 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.
Essentially this breaks down into: Drivers who deliver food or laundry; life insurance agents; craftsmen and craftswomen who work from home; and traveling salespeople. The third category is the broadest. It can apply to almost anyone who does work from home as long as they physically make things, the employer provides the raw materials and specifies who the worker should bring the finished product to.
Within these four categories the worker must meet the following conditions:
• The contract for services calls for them to do the work personally. In other words, a driver who subcontracts to other drivers is not a statutory employee.
• Aside from owning their own transportation, they do not have a "substantial investment" in their equipment. In other words, while you can buy your own car, if you also bought your own sewing machines you will probably not qualify.
• They provide these services continuously for a single payer. In other words, if you have five different clients you will probably not qualify.
If you are employed as a driver, salesperson or craftsperson who works from home, and if you meet the three conditions set forth above, there is a good chance you are a statutory employee.
Do Statutory Employees Receive a W-2?
Statutory employees are paid with a W-2 instead of the 1099 common to contract workers. However, the employer does not withhold federal or state income taxes (when applicable). As a result you will need to make quarterly estimated tax payments.
What Are the Advantages of Being a Statutory Employee?
First, it is important to note that some outlets report the following information incorrectly when it comes to statutory employees:
• That the four categories are examples of who may be a statutory employee. This is not correct. You must fall into one of these initial four categories in order to qualify, then meet the three conditions test for qualifying workers within those categories.
• That a statutory employee is tax advantaged because they can deduct their business expenses on Schedule C. While true, this is ordinary tax preparation for independent contractors and it is essential to understand that a statutory employee is a category of independent contractor.
While you receive your pay on a W-2, in all circumstances except for payroll taxes the IRS treats statutory employees as contractors. As a result, while deducting your expenses is an advantage of being a contractor of any sort, it is not a specific benefit to being a statutory employee. Also remember that there's an upper limit to how many expenses you can claim. If you provide most of your own equipment you will probably be considered a contractor rather than a statutory employee.
The unique advantage of being a statutory employee is that you are an independent contractor, with all the freedom that entails, without having to pay the onerous self-employment tax. This amounts to a functional pay raise of 7.65% and is the best of both worlds.
Finally, there is a category of worker called "statutory nonemployees." These are workers who are always treated as contractors for federal tax purposes regardless of their relationship to the employer. Only three types of workers fall under this category:
• Licensed real estate agents;
• Direct salespeople;
• Some companion sitters.
For salespeople and real estate agents to be statutory nonemployees, they must work almost entirely on commission and must have a written contract specifying that are not employees. Companion sitters are generally deemed contract workers unless they are specifically employed by a service.
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