Retail Industry ATG - Chapter 3: Examination Techniques for Specific
Industries (Direct Sellers)
The services of a direct seller are any services that customarily are directly related to the trade or business of
selling (or soliciting the sale of) consumer products in the home or in any other location that does not constitute a
permanent retail establishment. Such services include any activity to increase the productivity of other individuals
engaged in such sales, such as recruiting, training, motivating and counseling such individuals.
A direct seller usually signs up with a particular company to sell its product line. The company may refer to the
direct seller by one of the following titles:
* Distributor or direct distributor
* Manager or supervisor
* Representative or sales representative
* Independent business owner
The above list of titles is not all inclusive.
Direct sellers are self-employed. This generally means that they have to pay self-employment tax. They must be
in business for themselves. Selling consumer products as a company employee does not make them direct
sellers. Likewise, working under another direct seller does not make them an employee of that direct seller.
An individual may be engaged in the trade or business of selling or soliciting the sale of consumer products if they
attempt to increase the sales of direct sellers who work under them (their down-line group) and their earnings
depend in part on how much that person sells. Recruiting, motivating, and training are examples of attempts to
increase direct seller sales. An individual is not a direct seller if they simply host a party at which sales are made.
IRC Section 3508(b) (2) defines the term “direct seller” to mean any person if –
* 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 or deposit-commission basis for resale by the buyer or any other person in the home or in some other place
that does not constitute 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 in some
other place that does not constitute a permanent retail establishment;
* 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
* Such person performs the services pursuant to a written contract between such person and the service-recipient
and the contract provides that such person will not be treated as an employee with respect to such services for
federal tax purposes.
According to the Direct Selling Association (DSA), a vast majority (99.9%) of all direct sellers are classified for
federal tax purposes as independent contractors. These independent business people are micro-entrepreneurs
whose purpose is to sell the product and/or services of the company they voluntarily choose to represent.
IRS Publication 15-A, Employer’s Supplemental Tax Guide, states that direct sellers are in the category of statutory
non-employees and are treated as self-employed for all federal tax purposes, including income and employment
* substantially all payments for their services as direct sellers 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.
Revenue Ruling 85-63, 1985-1 C.B. 292, holds that an individual who performs services as a direct seller, as
defined in IRC Section 3508, is liable for the tax on self-employment income. Proposed Regulations Section
31.3508-1(a) provides generally that an individual who performs services as a direct seller after December 31,
1982, shall not be treated as an employee with respect to such services, and the person for whom such services
are performed shall not be treated as an employer, for federal income and employment tax purposes.
Revenue Ruling 85-63 discusses the following factual situation:
B, an individual, performs services selling consumer household products door-to-door for Y, a corporation. These
services are performed under a written agreement which provides that, for federal tax purposes, Y will not treat B
as an employee. B is paid solely on a commission basis. B thus meets the description of a direct seller contained
in section 3508(b) (2) of the Code.
The direction and control that Y exercises over B in the performance of B’s services would establish the
relationship of employer and employee under applicable common-law rules. Thus, but for the application of
section 3508(a) of the Code, B would be Y’s employee within the meaning of section 3121(d) (2). Y does not
withhold FICA or federal income tax from the remuneration paid to B.
The Revenue Ruling holds that B is liable for the self-employment income taxes imposed by IRC Section 1401.
Questions to ask on this issue:
* Schedule C. Is the business properly being reported on the Schedule C, with net income being subject to self-
* Commissions, etc. Is the business expensing commissions, management fees, etc.? This could indicate that
family members are working for the business. Is a Form 1099 being issued for those individuals being [paid $600
or more] for any calendar year? Is the working family member the subject of an employee/employer relationship,
using the three classification issues of behavioral control, financial control and relationship/intent?
* Spouse Is the spouse working for the business and being treated as an independent contractor or employee?
Does the spouse receive any compensation at all? Is there proper treatment of spousal activity?
Employee v. Independent Contractor
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