How to Report Statutory Employee Income

Federal tax law classifies certain workers as statutory employees, a hybrid status that treats them as employees for some tax purposes and as independent contractors for others. This designation, created by federal statute, alters the tax responsibilities of both the worker and the employer. The arrangement directly impacts how payroll taxes are handled and how income is reported to the Internal Revenue Service (IRS).

Determining Statutory Employee Status

The IRS defines four types of workers who may be classified as statutory employees:

• Drivers who distribute beverages (excluding milk), meat, fruit, vegetable, or bakery products, or who handle laundry or dry-cleaning delivery and pickup, if they are paid on commission or act as an agent.
• Full-time life insurance sales agents whose main business is selling life insurance or annuity contracts for a single company.
• Individuals who work from home using materials or goods supplied by a payer, which must be returned to the payer, and for whom the payer provides work specifications.
• Full-time traveling or city salespersons who solicit orders on behalf of a single principal from entities like wholesalers, retailers, or contractors for merchandise intended for resale or business use.

For a worker in one of these roles to be considered a statutory employee for Social Security and Medicare tax purposes, three additional conditions must be met. The service contract must state or imply that the services will be performed personally by the individual. The worker cannot have a substantial investment in the equipment and property used, though an investment in transportation is allowed. The services must also be performed on a continuing basis for the same payer.

Tax Treatment of Statutory Employee Income

The tax treatment for a statutory employee blends rules for both employees and independent contractors. For payroll tax purposes, they are treated as employees, meaning the employer withholds Social Security and Medicare (FICA) taxes from their pay. The employer also pays the corresponding employer’s share of these taxes, just as they would for a common-law employee.

A distinction arises with federal income tax. Employers are not required to withhold federal income tax from a statutory employee’s wages, placing the responsibility for paying these taxes on the worker.

To manage this liability and avoid underpayment penalties, statutory employees often need to make quarterly estimated tax payments to the IRS. These payments cover their projected income tax for the year.

Reporting Income and Deducting Expenses

The reporting process begins by confirming this status on the Form W-2, where the “Statutory employee” box in Box 13 will be checked. The income shown in Box 1 of the W-2 is not reported as standard wages. Instead, the statutory employee reports this income on Schedule C (Form 1040), Profit or Loss from Business. The gross income is entered on Line 1 of Schedule C, and a box on that line must be checked to indicate the income is from statutory employment.

Because FICA taxes were already withheld, these earnings are not subject to self-employment tax. Reporting on Schedule C allows the statutory employee to deduct ordinary and necessary business expenses from their income, similar to an independent contractor. This reduces the individual’s adjusted gross income (AGI) and overall tax liability.

Common deductions include:

• Vehicle expenses, using either the standard mileage rate or actual costs
• Supplies
• Costs for a qualifying home office
• Professional insurance premiums