As an employer, you might have scenarios where you hire employees under contract. Although a contract worker doesn’t require any tax and benefit considerations at your end, if they strictly work for you, use your site and equipment, and have a continuous relationship with you, they might be classified as a “statutory employee” by the IRS.
Contractors that fall into specific categories and meet certain conditions are considered statutory employees in the government’s eyes. This classification has tax implications for you. In fact, misclassification of contractors can lead to penalties. Here we look at the categories and conditions applying to employees by statute and the tax and benefit implications they present.
What is a Statutory Employee?
A statutory employee is a contract worker falling into one of the following four categories according to the IRS:
- A driver who is your agent or paid on commission to distribute nondairy beverages, meat, vegetable, fruit, or bakery products; or pick up and deliver laundry or dry cleaning.
- A full-time life insurance sales agent who sells life insurance and/or annuity contracts, chiefly for one life insurance company.
- Someone working at home using materials or goods you supply, or that must be returned to you or someone you specify.
- A full-time traveling or city salesperson whose principal business activity is working on your behalf to receive orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments.
They must also then work under the falling conditions:
- You have a service contract stipulating any of the above services must be performed personally by the individual.
- The worker doesn’t require a substantial investment in the equipment they use or uses the equipment and supplies provided by you.
- The services must be provided as part of a continuing relationship.
Recognizing when a contractor is actually a statutory employee is important because the IRS requires you to withhold their FICA taxes and also contribute your share. However, statutory employees can also save you money, as you don’t have to provide benefits such as health insurance.
Tax Implications of Having Statutory Employees
Tax withholding for statutory employees tends to be more complex. The main challenge is that setting up payroll for them has to be done properly to ensure you comply with withholding laws. While you withhold and pay your part of Social Security and Medicare taxes (FICA), you are not responsible for withholding federal or state taxes. Therefore, when setting up their payroll, you have to ensure you properly flag their FICA taxes and, when paying taxes, include both their withholding and your FICA contributions. It’s your responsibility to ensure the statutory employee pays half of the required 12.4% Social Security and 2.9% required for Medicare.
Do Statutory Employees Receive a W2 Form?
Yes, at year-end, your statutory employees receive a W-2 form with Box 13 – Statutory Employee selected. The form includes:
- Their total wages
- The amount of Social Security withheld
- The amount of Medicare taxes withheld
However, you do not have to provide a 1099-NEC required for independent contractors.
Benefits for Businesses Hiring Statutory Employees
Although you can hire full-time employees for these roles, you can enjoy some cost savings and reduce liability by hiring statutory employees instead. For example, statutory employees do not receive benefits such as health care, retirement, paid leave, or vacation time. Although hiring a contractor might seem easier because you don’t contend with FICA, the contractor can provide the same services to other companies.
As a result, you don’t have a dedicated person to fill the role. When it comes to project-based work, you enjoy more flexibility when hiring statutory employees without the commitment required for regular team members.
Do Statutory Employees Receive Company Benefits?
No. Statutory employees do not receive company benefits. As a result, you save money on premiums.
Onboarding Statutory Employees: Forms and Documentation
When onboarding a statutory employee, a contract is required. The contract outlines the nature of the job they are hired to do, and the type of working relationship and includes a clear indication that their working classification is statutory. To avoid confusion, it helps to include details outlining what your responsibility is regarding withholding and what they are expected to pay. If the new hire has never worked in this capacity before, they might not understand their role in tax withholding and find themselves owing a large sum of taxes when tax time rolls around. ‘
Hiring a statutory employee does not require a Form W-4: Employees Withholding Certificate, and instead, they must complete Form W-9: Request for Taxpayer Identification Number and Certification. This form provides permission to collect their Social Security number for year-end filings.
Your statutory employees are entitled to your share of FICA contributions. However, you are not involved in withholding state or federal taxes. To ensure the IRS receives proper contributions required by law and that employers follow withholding regulations, they are very strict when it comes to proper employee classification. Therefore, as an employer, you want to understand who and who doesn’t meet the standards of a statutory employee.
Although misclassification can be an honest mistake, some employers purposefully misrepresent an employee’s classification to avoid tax responsibilities. Even if your misclassification is unintentional, you can still face penalties and potential lawsuits. Instead of struggling to classify employees, it’s best to submit a Form SS-8 to ask the IRS to make the determination.
If you are struggling with employee classification, onboarding processes, and proper tax withholding processes, it helps to work with an expert. Using appropriate tax filing systems that automate the payroll process also helps avoid common filing errors. At Paypro, our team of dedicated payroll and tax specialists provide personalized advice.
We can also implement a payroll automation system to ensure you remain compliant with the complexities of withholding rules and regulations for all employee classifications. Set up a demo with our team today.