Employee, Contractor, or Statutory Employee: Who Are They?

One of the questions we are asked most frequently is “Who is an employee?” The answer to this question has significant financial and legal implications for your business.

Here are some pointers to help you make this determination for your particular circumstances and point you to resources that will give you confidence in your decision.

Many businesses would prefer to pay all individuals as independent contractors, who do not legally require employer taxes, employee tax withholding or benefits.

In recent years, the IRS has paid particular attention to the determining of worker status, due to the loss of billions in uncollected taxes from those employers who pay employees as contractors instead.

While there is no simple rule for all purposes and all jurisdictions, there are numerous factors which can be looked at together to help determine who is an employee and who is not.

The IRS uses something called the 20 Factor Test to determine how much control the business exercises over the manner in which the work is done, the schedule of the work and resources used.

Generally, when a business controls or has the right to control what work will be done and when, where and how – then the worker is an employee.

The most common way to determine if someone is a contract worker is to rule out any factors that would make them an employee. A worker is only a contractor if you can only control the result of the work.

For example, when hiring a painter to paint your home, you have the right to determine an agreed upon price, a deadline for completion and whether the work is done to your satisfaction – and little else. Otherwise, they are considered a common law employee.

The IRS states: “Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”

Workers can be assigned to one of four classifications that govern how they must be treated for tax purposes. They are employee (common law), independent contractor, statutory employee and statutory non-employee.

Even if a worker might be considered a contract worker under the common law guidelines, there a four special circumstances that would render them a Statutory Employee.

Access these exceptions, and additional contingent considerations here..

In short, the exceptions are:

Food and laundry delivery drivers who are agents or receive commission
Life insurance agents who sell primarily for one insurance company
Home workers using materials you provide to create items to your specifications to be delivered back to your company or customer
Salesmen or saleswomen who sell goods to other businesses for resale or use in their businesses

When these special cases also are required to 1) Perform the services personally, 2) Do not have a large investment in tools or equipment and 3) Provide these services continually to the same base of clients, then they are considered Statutory Employees.

There are also three kinds of workers that must be treated as Statutory Non-employees, thus as contract workers.

They are:

Direct sellers
Licensed real estate agents
Companion sitters not employed by a placement service

If payments are made to the sellers and agents only for sales produced and not based on any expectation of hours and they are employed under a contract that states they will not be treated as employees for tax purposes, then they are Statutory Non-employees.

If in doubt, submit this IRS Form SS-8 for an official determination.

Here are the complete IRS guidelines.

Ultimately, if you decide that you can treat workers as independent contractors, you may wish to consult a labor attorney or CPA to be sure you make the right call. It is always safe to treat a worker as an employee, and for most companies, this is almost always the right answer.

Call Southwestern Payroll with any questions to help you clarify whether your workers are employees or something else.

Additional information is available here from the Department of Labor.