Classification as a Statutory Employee

By John C. Zimmerman, CPA (inactive), MS (Tax), J.D., and Tom McCaslin, CPA, Ph.D.


  • Employers are not required to withhold tax from the wages of statutory employees but are required to withhold and pay Social Security and Medicare tax for these employees. A statutory employee is allowed to deduct employment expenses on Schedule C instead of as miscellaneous itemized deductions on Schedule A.
  • Statutory employees include certain agent-drivers or commission-drivers, full-time insurance salespersons, certain home workers, and certain traveling salespersons that sell to business customers.
  • A number of factors are considered in determining whether an individual is a statutory employee, the most important being the amount of control the person’s employer exerts over the person in the performance of his or her job duties.
  • The receipt of materials from an employer is critical in the determination of whether a person is a home worker under the statutory employee rules.

Most workers are classified as either an employee of someone else or self-employed. Each status has its advantages and disadvantages. Self-employed individuals have the advantage of being able to deduct their expenses on a Form 1040, Schedule C, Profit or Loss from Business, as direct offsets to income. However, they must pay the self-employment tax, which comprises the employer and employee share of FICA tax. 1 Employees pay only one-half of the Social Security and Medicare taxes, while the employer pays the other half. However, employees do not have the advantage of being able to deduct their expenses directly against income. Rather, employee business expenses are itemized deductions that are subject to the 2% of adjusted gross income limitation. For practical purposes, this means that many employees are not able to realize any tax deduction for their unreimbursed business expenses.

However, one category of workers—statutory employees—can enjoy the best of both worlds. They are like independent contractors but without substantial investment in the facilities used in the performance of services. The determination of who qualifies as a statutory employee turns on the facts of the situation.

Statutory employees take direct deductions for their trade or business expenses against income on Schedule C, the same as self-employed individuals. However, they pay only one-half of their Social Security and Medicare taxes, with the employer paying the other half, just as if they were employees. Income tax is not withheld from statutory employees’ wages. Although not considered to be self-employed, statutory employees still complete a Form 1040, Schedule C. They receive a Form W-2 that will have box 13, Statutory Employee, checked. Rev. Rul. 90-93 emphasizes that statutory employees are not employees for purposes of Secs. 62 (computation of adjusted gross income) and 67 (2% floor on miscellaneous itemized deductions). 2 For purposes of the federal unemployment tax (FUTA), only the first and last categories of statutory employees listed below are subject to it. The second and third categories are not subject to FUTA. 3

Why Statutory Employees?

Unfortunately, there are no statistics detailing the number of taxpayers who file as statutory employees. The early legislative history ties the classification to a congressional desire that all employees be covered by Social Security. The Senate Finance Committee reported in 1950 that

the usual common-law rules for determining the employer-employee relationship fall short of covering certain individuals who should be taxed at the employee rate under the old-age and survivors insurance program. The statutory provisions set forth in paragraph (3) [now Sec. 3121(d)(3)] are designed to extend the definition [of employee] to include those individuals who, although not employees under the usual common-law rules, occupy substantially the same status as those who are employees under such rules. 4

The House of Representatives report further explained that the statutory employee provisions relate to “well-known occupational areas from which much of the present uncertainty and past litigation on this question has evolved” and that the groups were included as statutory employees “to assure the application of the [Social Security] employee tax rate to individuals who work in these occupations.” 5

Who Is a Statutory Employee?

The term “statutory employee” is not used in the Internal Revenue Code. However, Sec. 3121(d)(3) defines the type of employee who is eligible to take advantage of these provisions. The individual must be classified as an employee who performs services for remuneration and is:

  • An agent-driver or commission-driver who distributes meat products, vegetable products, fruit products, bakery products, or beverages (other than milk), or who picks up or delivers laundry or dry-cleaning for his or her principal.
  • A full-time insurance salesperson.
  • A home worker who performs work according to specifications of the person for whom the services are being performed, on materials or goods furnished by the person. The work product must be returned to the person or someone designated by him or her.
  • A traveling or city salesperson, other than an agent-driver or commission-driver (covered in the first point above), engaged on a full-time basis in the solicitation on behalf of a principal of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments for merchandise for resale or supplies for use in their business. However, the full-time basis rule will not be violated if the salesperson also performs some sideline activities for a person other than the principal.

The service contract between the employer and the statutory employee must provide that substantially all the services performed by the above classifications of employees must be performed personally by the individual. However, the rules for a statutory employee will not apply to an individual who has a substantial investment in the facilities used in the performance of the services (other than transportation facilities). Therefore, the individual will be allowed to own a personal auto for transport in the performance of the services. The rules will also not apply if the services are in the nature of a single transaction that is not part of a continuing relationship. A substantial investment in facilities indicates the worker is an independent contractor. 6

A General Counsel Memorandum 7 explains the limitations on the requirement that the individual not have a substantial investment in the facilities. It ruled that the purchase of the exclusive rights to distribute and sell baked goods does not constitute a purchase of “facilities” under Sec. 3121(d)(3). The memo states that “the legislative history for section 3121(d)(3) . . . indicates an intent to provide relief to a described group of individuals and a further intent that the exception based on investment in facilities not be interpreted broadly so as to undercut the intended relief.” It cited from the original legislative history that “the facilities here pertinent include equipment and premises available for the work or enterprise as distinguished from education, training, and experience, but do not include such tools, instruments, equipment, or clothing as are commonly or frequently provided by employees.”

Regs. Sec. 31.3121(d)-1(d)(3) explains in greater detail the application of the section to the four categories.

Agent or commission driver: An agent-driver or commission-driver includes an individual:

  • Who operates his or her own truck or the truck of the person for whom services are performed;
  • Who serves customers designated by his or her principal as well as those he or she solicits; and
  • Whose compensation is based on either a commission or the difference between the amount he or she charges the customer and the amount he or she pays to the principal for the product or service.

Life-insurance salesperson: Full-time life-insurance salespeople devote their entire or principal business activity to the solicitation of life insurance or annuity contracts, or both, primarily for one life insurance company. They will normally use office space provided on the company’s premises and secretarial and company materials provided without cost. The salespeople will not be considered statutory employees if (1) their employment contract does not contemplate that they will perform their services for only one company or (2) only a part of their endeavors are devoted to the solicitation of life insurance and annuity contracts.

Home worker: A home worker performs services:

  • Off the principal’s business premises;
  • According to specifications provided by the principal;
  • On materials or goods provided by the principal; and
  • That are required to be returned to the principal or someone designated by him or her.

It needs to be emphasized that the place where the home worker performs the services does not have to qualify for the home office deduction defined in Sec. 280A. Moreover, a literal reading of the statute and regulations suggests that the services do not even have to be performed at the employee’s home. Rather, it is only necessary that the employee perform the services away from the employer’s premises.

Traveling or city salesperson: Traveling or city salespeople solicit orders off the employer’s premises and are usually compensated on a commission basis. Their employer does not control how they perform the services, but such salespeople “are expected to call on regular customers with a fair degree of regularity.” 8 The salesperson must devote his or her entire or principal business activity to soliciting orders for one principal. Hence, a multiple line salesperson—one who solicits orders for more than one principal—will not be considered a statutory employee. However, it is permissible for the salesperson to solicit orders for others on a minor basis. Example (1) in Regs. Sec. 31.3121(d)(3)(iv) illustrates the case of a pharmaceutical salesperson who works primarily for one company but occasionally solicits orders for two other companies. The salesperson will be a statutory employee for his main employer but not for the other two companies. Example (2) illustrates the case of a full-time salesperson who solicits orders for two companies and who will not be considered a statutory employee for either employer.

It is important to note that the statute specifies that the traveling salesperson designation applies only to those who solicit orders from businesses that use the purchased goods for either resale or in the business. It does not apply to someone who solicits individuals other than in their capacity in a trade or business. Example (3) in Regs. Sec. 31.3121(d)(3)(iv) gives the illustration of a salesperson who solicits orders house to house on behalf of a company and only occasionally solicits orders from businesses. The salesperson would not be classified as a statutory employee.

Note: Only the classifications of employees listed in the Code and regulations, discussed above, will qualify. For example, real estate salespersons are governed by Sec. 3508 and do not qualify for statutory employee status. In Tavella, 9 the taxpayer, a fundraising consultant for synagogues, argued that he should be treated as a statutory employee. He based his argument on the premise that the type of work he did was similar in nature to an insurance salesperson’s work and that he even competed with such salespeople for the same clients. The Tax Court rejected this argument because his occupation was not listed in Sec. 3121(d)(3). The court noted that the occupations listed in the Code were not merely illustrations but were intended to be exhaustive. Similarly, in Kelly, 10 where a taxpayer performed makeup services in the entertainment industry, the Tax Court rejected her claim to be a statutory employee because she did not fall under any of the permissible occupations for this classification.

Classifying a Statutory Employee

The problem that arises in defining exactly who qualifies as a statutory employee is that while the classification falls somewhere between a common law employee and an independent contractor, it leans more toward the latter. A statutory employee will need to exhibit more of the characteristics of an independent contractor than those of an employee.

The Tax Court has stated that the intent of the parties is important in determining common law or statutory employee status. Intent can be inferred from whether the employer checks the box on the Form W-2 that identifies whether the employee is a statutory employee. The court will also look to whether the employee is entitled to benefits such as a 401(k) plan, health insurance, sick leave, and vacations. The more benefits to which the employee is entitled, the more likely common law employee status will be found. 11

The regulations state: “In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor.” 12 In Ewens and Miller Inc., 13 the Tax Court listed a seven-factor test to determine whether an individual is a common law employee or an independent contractor:

  • The degree of control exercised by the principal;
  • Which party invests in work facilities used by the individual;
  • The individual’s opportunity for profit or loss;
  • Whether the principal can discharge the individual;
  • Whether the work is part of the principal’s regular business;
  • The permanency of the relationship; and
  • The relationship the parties believed they were creating.

The court noted that all the factors would be considered together and that no one factor was determinative. However, the court did focus on the first factor, dealing with control. The less control, the more likely one would be an independent contractor. On the other hand, to be classified as an employee it is not necessary for the employer to exercise constant supervision. Thus, “the employer need not set the employee’s hours or supervise every detail of the work environment to control the employee.” 14

The Ewens and Miller employer was a bakery company that had reclassified all its workers from employees to independent contractors. There were four classifications of workers. The court held that three of these classifications were common law employees, while the route distributors were statutory employees. In applying the seven-factor test to each of the four worker classifications, the Tax Court showed that the route distributors had a greater degree of control over their work and independence of action than the other employees. Hence, they were found to come within the definition of an agent-driver in the Code and regulations. The court found that the route distributors:

  • Did not have a substantial investment in the facilities other than those used for transportation;
  • Served customers designated by their employer as well as those they solicited on their own;
  • Received their compensation as either a commission on their sales or the difference between the price they charged and the price paid for the employer’s bakery products; and
  • Set their own hours.

The court did not discuss what factors would be necessary for the route distributors to be classified as independent contractors. However, it appears that if the only customers they had were those that they solicited on their own and the employer provided none of them, this would have been sufficient to be independent contractors. As noted above, the regulations state that to be an agent-driver, and thus a statutory employee, it is necessary that the individual “serves customers designated by [his principal] as well as those solicited on his own.” 15

In a subsequent case involving a bakery, 16 a common law employee relationship was found to exist where the employee’s duties involved reporting each morning at a specified time to a distribution facility and loading the delivery vehicle provided to him, from which he proceeded to deliver the products to store locations on a route designated for him. He was required to punch a time clock each day at the beginning and end of his deliveries. He could make deliveries only on the route designated for him by his employer. He was also required to become a member of a labor union, the Teamsters, which had a collective bargaining agreement with the employer.

Home Workers

The absence of a common law employee relationship will not necessarily guarantee statutory employee status. Rev. Rul. 74-62 17 involved home workers who made Christmas wreaths. Although the company provided some of the materials necessary for making the wreaths, the workers provided evergreen tips, the principal material. The workers were under no obligation to sell their finished product to the company. Moreover, the workers were free to not use the material provided by the company if comparable materials could be acquired elsewhere. The company even permitted the workers to purchase the finished product from another manufacturer and resell it to the company. The company did not exercise any control over how the workers made the wreaths. The IRS held that because (1) the principal materials used to make the wreaths were provided by the workers and (2) the workers were not required to sell their finished products to the company, they were independent contractors, not statutory employees.

The IRS has been lenient in interpreting the requirement, in relation to home workers, that the individual not have a “substantial investment in the facilities used in the performance of the services” in order to be considered a statutory employee. In a technical advice memorandum (TAM), 18 the IRS had to decide whether this requirement was violated where the home workers made clothing with their own equipment. The TAM noted that “[g]enerally, the layman’s understanding of the phrase ‘substantial investment in facilities’ does not include small machines and tools such as sewing machines and shears, but connotes a structure or heavy equipment that is built, installed or established to serve a particular purpose.” Facilities “do not include such tools, instruments, equipment, or clothing, as are commonly or frequently provided by employees.” The TAM held that this interpretation was consistent with the legislative history accompanying the original Code section. “An in-depth review of the legislative history indicates that it is directly on point to the home workers at issue.”

In VanZant, 19 the taxpayer worked for a school district from her home. Though she was held not to be a common law employee, the issue was whether she was an independent contractor or a statutory employee. At issue was the definition of a “home worker” as specified in Sec. 3121(d)(3)(C). VanZant was an educational consultant for the Los Angeles Unified School District. She was required to visit schools, collect data, and enter the collected data into a software template provided by Action Learning Systems (ALS), the organization for which she worked. ALS determined which schools she would service and supplied the material and format for submitting the data. She had to attend training sessions at ALS’s facilities. At these sessions she was given a training manual, a CD with the template on it, and instructions on how to collect and enter data. VanZant e-mailed the templates to ALS after the data were entered. ALS gave her a Form 1099-MISC, Miscellaneous Income, did not withhold FICA taxes, and hence classified her as an independent contractor.

VanZant claimed that she was a statutory employee under the Sec. 3121(d)(3)(C) definition of a home worker. Although she met the requirement of performing her home tasks under the specifications of ALS, the IRS argued that she failed the overall test because she did not receive materials or goods from ALS, as required by the section. Essentially, the IRS argued that to be a home worker the taxpayer would have to be assembling items from materials in the manner that assembly is understood in the manufacturing sense. The Tax Court rejected this narrow definition. It noted that neither the Code nor regulations provide any guidance on the definition of goods or materials:

Yet, materials are typically the “tools or apparatus for the performance of a given task.” See The American Heritage Dictionary of the English Language 1079 (4th ed. 2006). Petitioner was required to use the ALS template to perform her duties. The ALS template is, therefore, a material. . . . Thus, petitioner performed services on materials or goods furnished by such person, which are required to be returned to such person. 20

Tax Planning Implications of VanZant

Since the Tax Court issued a summary opinion in VanZant, tax advisers cannot cite it as precedent. However, the case is important because it indicates that the Tax Court, and possibly other courts, is willing to take a broader view of the definition of “materials.” With the increase of workers who perform their duties away from the premises of the employer, a broadened definition of materials could assist many workers in the ability to claim statutory employee status.

A critical issue in obtaining statutory employee status is that the employee not provide his or her own materials, other than transportation. Rev. Rul. 87-41, 21 item 14, lists providing one’s own materials as evidence of an independent contractor. Tax professionals who advise employers may want to emphasize that if an employer wants home workers to be classified as independent contractors as opposed to statutory employees, it cannot provide them with materials. The turning point in VanZant between independent contractor and statutory employee status was the employer’s providing the template. If this is the standard for employer-provided materials that courts are going to apply in a world of virtual employment from the home, many employers may find that they are providing employees the materials needed to complete their tasks.

From the home employee’s perspective, it is much better to be classified as a statutory than a common law employee. Tax advisers can also counsel employers that, even when independent contractor status is not warranted for a home employee, statutory employee status will be advantageous for both the employer and the employee. The employer will not have to withhold income tax or pay FUTA. The employer also saves by not having to provide office space to the employee. Since the employee can directly offset expenses against income, the employer can use this as a selling point on the advantages of home employment.

Traveling or City Salesperson

Probably the most common type of statutory employee at present is the traveling salesperson defined in Sec. 3121(d)(3)(D). The determination of whether the statutory employee designation applies inevitably rests on the salesperson’s independence in the performance of duties. Too much control by the employer will result in common law employee status. In Cole, 22 the taxpayer traveled extensively on behalf of two employers for whom he worked at different periods of time. Neither employer had checked the box on the form W-2 that identifies a statutory employee. For both employers, Cole was directed to the clients, told where he needed to go, and what needed to be done. With one of the employers, he was not allowed to travel to clients’ offices or to incur any expenses without permission. With the other employer, he was required to turn in time sheets signed by the client stating that the work had been done satisfactorily. He received a regular salary at one employer and an hourly wage at the other, and he did not receive the commissions one would expect to find with a traveling salesperson. Both employers exercised a great degree of control over his work. Therefore, the court held he was a common law employee for both employers.

The problems that can arise in classifying a traveling salesperson were perhaps best illustrated in Hathaway. 23 Hathaway had been classified as a common law employee by his employer and was issued Forms W-2 for the years at issue. The employer withheld FICA and income taxes. Initially, Hathaway deducted his expenses as itemized deductions on Schedule A. However, he amended his returns for two years, claiming that he was a statutory employee, and filed a Schedule C for both years. The Tax Court examined his duties performed on behalf of the employer. He was found to have a great deal of control over his work. The employer did not control, or have the right to control, how Hathaway conducted his sales activities, the means by which he solicited sales, or the results to be obtained. Hathaway was not required to use specific sales techniques or materials in making sales presentations or finding customers. The employer did not provide sales training or require its sales representatives to attend sales meetings. Hathaway controlled the manner in which he solicited sales and the scheduling of his time. The court also found it important that the employer did not provide leads to its sales representatives, did not require them to pursue or report on leads, and did not have the right to change the method by which they solicited sales. Other relevant factors listed by the court were that Hathaway (1) was paid on a commission basis, (2) paid his own business expenses, (3) paid assistants in certain circumstances, (4) paid the costs of maintaining a business headquarters, (5) purchased materials and equipment from his employer, and (6) guaranteed customer credit in some situations.

One of the factors arguing against statutory employee status was that Hathaway had a substantial investment in facilities, an item indicating independent contractor status. In looking at all these factors, the court held that he was an independent contractor, thereby allowing him to amend his returns by filing a Schedule C. However, the court stated that it would not rule on the issue of whether he was a statutory employee. It was not necessary for an ultimate resolution of Hathaway’s situation because the employer had already paid its share of FICA taxes when it classified him as a common law employee. The court appears not to have considered important the fact that the employer had withheld income taxes, had not checked the statutory employee box on the Form W-2 (factors indicating common law employee status), and had paid the employer’s share of FICA (a factor indicating either common law or statutory employee status) for the two years at issue. Though not saying so directly, the court was adopting the substance over form doctrine: Even though the employer’s approach was to adopt the form for a common law employee, substantively the facts showed that either independent contractor or statutory employee status was warranted.

The Limits of Hathaway

The Hathaway decision will probably be of very limited use to taxpayers unless they are in the exact same situation. In the recent case of Rosato, 24 the taxpayer set his own hours, was not told when to work, could take days off as he chose, and could perform some of his sales work from home. He even paid half the cost of his secretary and administrative assistant and a portion of the cost for his office. However, the understanding he had with his employer was that he was an at-will employee, and the employer did not check the statutory employee box on the Form W-2. Rosato also participated in employer fringe benefit programs, a sign of common law employee status.

The Tax Court noted that, unlike Hathaway, Rosato was required to attend meetings and had superiors who oversaw and supervised his performance. The court stated: “Although not the exclusive inquiry, the degree of control exercised by the principal over the worker is the crucial test in determining the nature of a working relationship.” The Tax Court not only rejected Rosato’s claim to statutory employee status, but it also upheld the Sec. 6662 20% accuracy-related penalty for any underpayment due to a taxpayer’s negligence or disregard of the rules or regulations, or a substantial understatement of the income tax.

Prior Classification

A salesperson’s prior classification as a statutory employee will not necessarily guarantee a continued classification, even if the facts of employment have not changed. In Lickiss, 25 the Tax Court rejected the taxpayer’s argument that he should be treated as a statutory employee for 1988 simply because on administrative appeal for 1987 he had been granted such classification. The court stated that it had been “well established” that the IRS could not be prevented “from asserting a position as in the instant case, even though no objection was raised to similar circumstances in prior years.” The court also rejected the taxpayer’s argument that he should be treated as a statutory employee because similarly situated employees received this treatment. The court noted that “it has long been the position of this Court that our responsibility is to apply the law to the facts of the case before us and determine the tax liability of the parties before us; how the Commissioner may have treated other taxpayers has generally been considered irrelevant in making that determination.”

In a subsequent case, 26 the court held that even though the IRS auditor had allowed statutory employee status for a traveling salesperson in 1995 and 1996, this would not preclude the IRS from asserting common law employee status for the years 2004 and 2005. The court stated: “As the Court informed petitioner, each taxable year stands alone, and the Commissioner may challenge in a succeeding year what was condoned or agreed to in a previous year.”


Statutory employees are allowed the benefit of direct deductions against income enjoyed by Schedule C filers without the self-employment tax burden such filers face. However, the ability to file as a statutory employee applies only to the categories of employees listed in Sec. 3121(d)(3). To be classified as a statutory employee, the worker must exhibit more of the traits of an independent contractor than of a common law employee. Generally, this means that the employee has control over how work is accomplished with a minimum amount of input by the employer. Courts will often look to the intent of the parties to determine statutory employee status. A critical component of intent is whether the employer has checked the Form W-2 box identifying a statutory employee. However, as shown in Hathaway, even when the employer fails to check the box and withholds income taxes—factors indicating common law employee status—the overall facts may support allowing the worker to file a Schedule C.

Authors’ note: This article is in memory of Jim Swayze.


1 This amounts to 15.3% on the Social Security base of $106,800 in 2010. The 15.3% is allocated 12.4% to Social Security and 2.9% to Medicare. For all earnings from self-employment in excess of the Social Security base, the taxpayer must pay the 2.9% Medicare tax.

2 Rev. Rul. 90-93, 1990-2 C.B. 33.

3 IRS Publication 15-A, Employer’s Supplemental Tax Guide (2009), p. 5.

4 S. Rep’t No. 1669, 81st Cong., 2d Sess. 144 (1950).

5 H.R. Rep’t No. 1300, 81st Cong., 1st Sess. (1949).

6 Hathaway, T.C. Memo. 1996-389.

7 General Counsel Memorandum 39853 (7/8/91).

8 Regs. Sec. 31.3121(d)-1(d)(3)(iv)(A).

9 Tavella, T.C. Summ. 2009-76.

10 Kelly, T.C. Memo. 1999-140.

11 Rosemann, T.C. Memo. 2009-185.

12 Regs. Sec. 31.3306(i)-1(b). See also Regs. Sec. 31.3401(c)-1(b).

13 Ewens and Miller Inc., 117 T.C. 263 (2001). The IRS has set forth a 20-factor test; see Rev. Rul. 87-41, 1987-1 C.B. 296.

14 Ewens and Miller Inc., slip op. at 13, citing General Inv. Corp., 823 F.2d 337 (9th Cir. 1987).

15 Regs. Sec. 31.3121(d)-1(d)(3)(i).

16 Rabago, T.C. Summ. 2002-153. See also Morris, T.C. Summ. 2001-2.

17 Rev. Rul. 74-62, 1974-1 C.B. 291.

18 TAM 9511001 (3/17/1995).

19 VanZant, T.C. Summ. 2007-195.

20 Id., slip op. at 5.

21 Rev. Rul. 87-41, 1987-1 C.B. 296.

22 Cole, T.C. Memo. 2006-44. See also Rivera, T.C. Summ. 2004-77.

23 Hathaway, T.C. Memo. 1996-389.

24 Rosato, T.C. Memo. 2010-39.

25 Lickiss, T.C. Memo. 1994-103.

26 Rosemann, T.C. Memo. 2009-185.


John Zimmerman and Tom McCaslin are associate professors of accounting at the University of Nevada–Las Vegas in Las Vegas, NV. For more information on this article, contact Prof. Zimmerman at

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