A statutory nonemployee is a worker whom federal law places outside employee treatment and treats as self-employed, whatever the common-law control test would say about the same facts. There are three categories: direct sellers, licensed real estate agents, and certain companion sitters. Direct sellers and licensed real estate agents are treated as self-employed for all federal tax purposes, including income and employment taxes, if substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output rather than to the number of hours worked, and their services are performed under a written contract providing that they will not be treated as employees for federal tax purposes (IRS, Publication 15-A).
Read the three as two rules rather than one. Two categories sit in a single Code section with a shared three-part test and one shared consequence. The third sits in a different section, reaches a different party, and does something narrower than the label suggests.
Where the Label Sits Among the Four Relationships
Before you can know how to treat payments made to a worker, you have to know the business relationship, and the person performing the services may be an independent contractor, a common-law employee, a statutory employee, or a statutory nonemployee (IRS, Publication 15-A).
The four are four different treatments of a payment, and they are not four different kinds of person. A statutory employee, for one, is a worker the common-law control test would call a contractor, so the labels can describe the same facts and still carry different tax consequences. What the ordinary contractor category is, and the control test that produces it, is set out in independent contractor. The label that runs in the opposite direction is set out in statutory employee.
The Statute Behind Two of the Three
The rule opens with its own scope. For purposes of this title, in the case of services performed as a qualified real estate agent or as a direct seller, the individual performing such services shall not be treated as an employee, and the person for whom such services are performed shall not be treated as an employer (26 U.S.C. 3508(a)).
Both limbs travel together. It is not only that the worker is not treated as an employee; the person for whom the services are performed is not treated as an employer on those same services, and the statute says both in one breath. The employment taxes that ride on employer status are set out in payroll tax.
Qualified Real Estate Agent
The term qualified real estate agent means any individual who is a sales person if three conditions all hold: such individual is a licensed real estate agent; substantially all of the remuneration, whether or not paid in cash, for the services performed by such individual as a real estate agent is directly related to sales or other output, including the performance of services, rather than to the number of hours worked; and the services performed by the individual are performed pursuant to a written contract between such individual and the person for whom the services are performed, and such contract provides that the individual will not be treated as an employee with respect to such services for Federal tax purposes (26 U.S.C. 3508(b)(1)).
The opening words carry weight and get dropped often. The definition reaches an individual who is a sales person, so a licence alone does not put someone inside it, and the three lettered conditions are joined by and rather than by or.
The category is wider than a broker’s transaction desk in one respect. It includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output (IRS, Publication 15-A).
Direct Seller
The direct seller definition has the same shape with a disjunction inside its first condition. The term direct seller means any person if, first, such person is engaged in the trade or business of selling, or soliciting the sale of, consumer products to any buyer on a buy-sell basis, a deposit-commission basis, or any similar basis which the Secretary prescribes by regulations, for resale by the buyer or any other person in the home or otherwise than in a permanent retail establishment; or is engaged in the trade or business of selling, or soliciting the sale of, consumer products in the home or otherwise than in a permanent retail establishment; or is engaged in the trade or business of the delivering or distribution of newspapers or shopping news, including any services directly related to such trade or business (26 U.S.C. 3508(b)(2)(A)).
Any one of those three routes will do. The remaining two conditions then apply on top of whichever route was taken, and both are required: substantially all the remuneration, whether or not paid in cash, for the performance of the services described above is directly related to sales or other output, including the performance of services, rather than to the number of hours worked, and the services are performed pursuant to a written contract between the person and the person for whom the services are performed, and that contract provides that the person will not be treated as an employee with respect to such services for Federal tax purposes (26 U.S.C. 3508(b)(2)(B) and (C)).
The newspaper and shopping news route is the newest of the three. It was added by a 1996 amendment that applies to services performed after December 31, 1995 (26 U.S.C. 3508, editorial notes).
Direct selling also reaches the person above the seller. It includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers, and such activities include providing motivation and encouragement, imparting skills, knowledge or experience, and recruiting (IRS, Publication 15-A).
The Exception Inside the Section
The section carries its own carve-out and it is easy to miss because it sits at the end. This section shall not apply for purposes of subtitle A to the extent that the individual is treated as an employee under section 401(c)(1), relating to self-employed individuals (26 U.S.C. 3508(b)(3)).
So the nonemployee treatment is not absolute across the whole Code. The general rule reaches the whole title, and this paragraph pulls one subtitle back out of it: where that self-employed individuals provision treats the individual as an employee, section 3508 stands down to that extent and for that subtitle only. The plan rules the provision serves are drawn in qualified retirement plans.
Companion Sitters Are a Different Rule Doing a Narrower Thing
The third category is not in section 3508 at all, and reading it as though it were is the common error.
For purposes of this subtitle, a person engaged in the trade or business of putting sitters in touch with individuals who wish to employ them shall not be treated as the employer of such sitters, and such sitters shall not be treated as employees of such person, if such person does not pay or receive the salary or wages of the sitters and is compensated by the sitters or the persons who employ them on a fee basis (26 U.S.C. 3506(a)). The term sitters means individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled (26 U.S.C. 3506(b)).
Three differences from section 3508 change what a file looks like.
The scope words are narrower. Section 3508 opens for purposes of this title and section 3506 opens for purposes of this subtitle, so the sitting rule speaks to the employment tax subtitle rather than to the Code as a whole.
The two conditions are joined. The placement service must neither pay nor receive the salary or wages, and it must be compensated on a fee basis by the sitters or by the people who employ them. Failing either one leaves the placement service inside employer status.
And the rule is about the placement service, not about the household. Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes, but the companion sitter may be an employee of the individual for whom the sitting services are performed (IRS, Publication 15-A). That second possibility puts the family, not the agency, in the payroll seat, and what that involves is set out in household employee.
How the Pay Gets Reported
Direct sellers carry a reporting rule that no other category has, and it is a checkbox rather than an amount.
Enter an X in the checkbox for sales by you totaling $5,000 or more of consumer products to a person on a buy-sell, deposit-commission, or other commission basis for resale, by the buyer or any other person, anywhere other than in a permanent retail establishment, and do not enter a dollar amount in this box (IRS, Instructions for Forms 1099-MISC and 1099-NEC).
A payer may use either box 2 on Form 1099-NEC or box 7 on Form 1099-MISC for it, and where Form 1099-NEC is used to report those direct sales, the form is required to be filed with the IRS by January 31 (IRS, Instructions for Forms 1099-MISC and 1099-NEC). The report given to the recipient for these direct sales need not be made on the official form and may be a letter showing the information along with commissions, prizes and awards (IRS, Instructions for Forms 1099-MISC and 1099-NEC).
Which of the two forms carries what else is a separate question, worked through in the two nonemployee information returns.
Withholding does not disappear in every case. Where an individual who works for you is not an employee under the common-law rules, you generally do not have to withhold federal income tax from that individual’s pay, but in some cases you may be required to withhold under the backup withholding requirements (IRS, Publication 15-A).
Common Questions
No. They are two of the four relationships a payer has to distinguish before treating any payment (IRS, Publication 15-A), and the route into each is what separates them. An ordinary contractor gets there by failing the common-law control test. A statutory nonemployee gets there by landing in a named category and meeting that category’s written conditions, which is why the written contract clause is not optional paperwork but part of the test itself (26 U.S.C. 3508(b)).
For the two section 3508 categories the treatment is self-employed for all federal tax purposes, including income and employment taxes (IRS, Publication 15-A), and the one qualification written into the statute is the retirement plan carve-out at section 3508(b)(3) (26 U.S.C. 3508(b)(3)). For a companion sitter the answer depends on who the employer turns out to be, because the statute only removes the placement service from that role (26 U.S.C. 3506(a)).
The category test fails. The written contract condition is one of the lettered conditions in each definition, joined to the others by and, and it has to provide that the person will not be treated as an employee with respect to such services for Federal tax purposes (26 U.S.C. 3508(b)). Without it the worker is classified under whichever of the other three relationships the facts support.
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