What it means
The IRS says workers who are independent contractors under common-law rules may still be treated as employees by statute for certain employment tax purposes. They must fall within one of four categories and meet three conditions.
The first category is 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 an agent or paid on commission. A full-time life insurance sales agent selling mainly for one company also qualifies.
Also covered is a person who works at home on goods supplied by the payer and returned to it, under the payer's specifications. The last category is a full-time travelling or city salesperson who turns in orders from wholesalers, retailers or similar businesses.
The three conditions apply to Social Security and Medicare withholding. The contract must state or imply that substantially all services are done personally, and the worker must have no substantial investment in equipment or property, other than transportation facilities.
The work must also be done on a continuing basis for the same payer. The result is a mixed status.
The payer withholds Social Security and Medicare tax at 6.2% plus 1.45% for each side, using the rates in the IRS guidance this entry relies on, and Social Security tax applies only up to an annual wage base that is set each year. The IRS says not to withhold federal income tax from these wages.
The worker then reports income and expenses on Schedule C, so business costs can be deducted. This is why the status can help: the worker avoids the full self-employment tax while keeping expense deductions.
Rules outside the US vary, and many countries have their own categories for workers who sit between employee and contractor.
In practice
Real-world examples.
Example
A fictional full-time life insurance agent sells only for one insurer and earns $52,000 in commissions. Her share of Social Security and Medicare is 7.65%, or $3,978, and the insurer pays the same amount. A self-employed worker would owe both halves, or $7,956.
Example
A fictional bakery pays a delivery driver on commission to distribute bread to cafes. The driver earns $40,000 and spends $6,000 on fuel and repairs. The bakery withholds payroll tax but no income tax, and the driver deducts the $6,000 on Schedule C.
Example
A fictional home worker assembles gift boxes from materials a company ships out and takes back, following its written specifications. She earns $18,000 and does the work personally. Because the work is done on the company's goods, she may be a statutory employee rather than a plain contractor.
Formula
Calculation
Payroll tax withheld = Wages x 7.65%, where 7.65% is 6.2% Social Security plus 1.45% Medicare. The worked figures assume wages below the annual Social Security wage base, which is set each year.
Worked example. A statutory employee earns $52,000 in commissions.
- Worker's share withheld = $52,000 x 0.0765 = $3,978, and the payer pays a matching $3,978.
- Self-employed comparison = Net earnings x 15.3% = $52,000 x 0.153 = $7,956.
- The worker's saving is $7,956 - $3,978 = $3,978, before other adjustments.
The worker still reports income and expenses on Schedule C and makes estimated income tax payments, because no federal income tax is withheld. Actual results depend on the year's rules.Case study
Seen in the real world.
This case study is fictional and illustrative. Luis sells packaged goods to grocers for one distributor and earns $64,000 a year in commissions. He assumed he was a contractor and paid his own payroll tax of $64,000 x 15.3% = $9,792. A review shows he meets the travelling salesperson category and the three conditions.
The distributor starts withholding Social Security and Medicare tax, so his share falls to $64,000 x 7.65% = $4,896. He still reports on Schedule C and deducts $9,000 of travel and samples. He also pays his own estimated income tax, since none is withheld. The change cuts his payroll tax bill by half, but he must check the rules every year.
Watch out
Common mistakes.
- Assuming a statutory employee is a full employee, when federal income tax is not withheld.
- Applying the label to any contractor, when only four defined categories qualify.
- Forgetting that the three conditions must be met for the payroll tax rules to apply.
Questions
People also ask.
What is a statutory employee?
It is a worker who is an independent contractor under common-law tests but is treated as an employee for some payroll taxes by law. The IRS lists four categories. Examples include some drivers, life insurance agents, home workers and travelling salespeople.
Does the payer withhold income tax?
No. The IRS says not to withhold federal income tax from statutory employee wages. The worker usually pays income tax through estimated payments.
Can a statutory employee deduct expenses?
Yes. Income and expenses are reported on Schedule C. That keeps business costs deductible in a way regular employees may not have.
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