Sometimes the line between an employee and an independent contractor can be blurry. It is very important for companies to be aware of this difference, as misclassifying an employee can cause issues for your business and potentially result in fines.
One important type of employee classification to be aware of is a statutory employee, which has some of the same features as both an employee and an independent contractor. Small businesses need to be aware of the IRS’s definition of a statutory employee, and ensure they remain up to date with tax and legal requirements.
What is a Statutory Employee?
Statutory employees are very similar to independent contractors but may be treated as employees for tax purposes. Some common types of statutory employees include delivery drivers, salesmen, insurance agents, and some individuals who work from home. Many of these statutory employees only work for one company, but have more freedom and flexibility than regular employees.
Statutory employees have to complete different tax forms, and companies need to ensure that they withhold the correct taxes if they hire a statutory employee. Statutory employees need to fill out Form W-2 when they file taxes and check the statutory employment box on line 13. These employees have social security and Medicare deducted from their salary like regular employees, but can also write off certain business expenses.
Statutory Employee vs Independent Contractor
Statutory employees and independent contractors have many similarities, and it may sometimes be confusing for companies and individuals to tell the difference. The main factor to note is that the roles of the jobs may be very similar, but the tax treatment is different.
Statutory employees generally work for only one company, while independent contractors typically offer their services to multiple companies. Employers who hire a statutory employee need to ensure that they properly manage the employee’s salary payment and that they report information and keep solid records. The biggest thing that small businesses should keep in mind is that there can be significant legal consequences if they misclassify an employee.
What Are the Tax Implications of Statutory Employees?
Companies that hire a statutory employee need to withhold social security and Medicare taxes, but not federal and state income taxes. In this case, the employer will pay half of the taxes and the statutory employee will pay the other half. Moreover, statutory employees are also responsible for paying state and local income taxes, as the employer does not withhold these taxes.
Statutory employees need to file W-2 forms when they file taxes, while independent contractors file a 1099 form. This W-2 form is different from the typical 1040 form that employees use when they file taxes. Statutory employees also need to deduct business expenses on the IRS Schedule C form instead of the Schedule A form.
While full-time employees may receive a variety of benefits, such as health insurance and 401Ks, statutory employees are generally not eligible to receive these benefits. One positive point to note is that statutory employees are also able to enjoy some of the same tax benefits as independent contractors. This is a very positive point, as full-time employees do not receive as large of a tax deduction for business expenses.
Compliance Risks and Best Practices
Your company could face IRS penalties for misclassifying workers, so you should be aware of the regulations on this issue. You could be forced to pay back employment taxes for the workers or worse.
Companies should consider some of the factors that the IRS analyzes when deciding if someone is an independent contractor. These include behavioral control, financial control, and relationships of the party. A common mistake is for a company to classify someone as an independent contractor and to control their work too much, which could result in them being classified as an employee.
In many cases, it may be hard to tell the difference between a statutory employee and a regular employee or independent contractor. Misclassifying workers can still result in fines and lawsuits, even if both the employer and the independent contractor agree on the classification.
Consult a tax professional to ensure your business has properly classified employees to ensure compliance. A tax professional can help you ensure that you correctly classify your employees and independent contractors, and stay up to date with any changes.
Closing Thoughts
Many companies have been choosing to hire more independent contractors for added flexibility and cost savings. However, it is very important for companies to be aware of the IRS’s rules regarding employee classification and to stay up to date with these changes. In some cases, it may be better for companies to hire statutory employees over independent contractors, as this classification offers the best features of both an employee and an independent contractor.
Companies that hire a combination of employees, statutory employees, and independent contractors should constantly review these members’ activities to ensure that they are not misclassifying any of them. Moreover, it may be helpful for companies to consult a tax professional to ensure that they are correctly classifying these employees and staying up to date with new changes.
Shared Economy Tax specializes in sophisticated tax strategies for small businesses and independent contracts. Get started now with a complimentary one-on-one strategy session, and see how much you can save.
