How Does Workers Compensation Apply to Employees Versus Contractors
Depending on applicable state statutes, individuals classified as nonemployees may be deemed employees under the law for the purposes of workers compensation. So it is important to understand if or when a workers compensation policy applies beyond the traditional employee relationship to other common forms of nonemployee labor, such as contract labor, independent contractors and service providers.
Many organizations engage nonemployee labor like independent contractors, consultants or temporary staff to augment their full-time staff. While this strategy may help businesses increase workforce flexibility and manage costs, it can also create unintended exposures under workers compensation. For example, if required by the state, a nontraditional employee may be eligible for benefits. Any payments made to them would be included in the payroll calculations used to determine premiums. This may lead to unanticipated increases in policy costs for the employer.
What makes a worker an employee under workers compensation?
Within the context of workers compensation insurance, an employee is generally someone for whom the employer pays unemployment taxes and issues a W-2 at year-end. Workers compensation insurance provides no-fault benefits to employees injured on the job. Typically, anyone whose wages you report on a W-2 and for whom you pay unemployment tax is considered an employee, while others are treated as nonemployee labor.
However, the issuance of a W-2 or payment of unemployment taxes is not the only factor used to determine employment status. A worker who receives a 1099 could still be deemed an employee by a workers compensation administrative agency, depending on various employment tests, such as the degree of control the employer has over how the work is performed and other indicators of an employment relationship.
What is nonemployee labor?
Nonemployee labor refers to workers who are not paid through company payroll and do not receive a W-2 at the end of the year.
Each category has a different impact on coverage and premium. Nonemployee labor may also be referred to as outside labor, nontax labor or even the blanket term subcontractors.
Nonemployee labor may be used by an employer for several reasons, including to supplement the existing workforce, perform work outside the scope of the organization’s purpose and provide a service to the employer.
Nonemployee labor can include:
- Contract labor – individuals under your direct supervision but not on payroll.
- Independent contractors – businesses that meet state independence tests.
- Service providers – outside firms such as accountants or janitorial services.
When can nonemployee labor implicate workers compensation?
Part 5 Section C 2 of a standard workers compensation policy states that the basis of premium includes payroll, and all other remuneration paid or payable for the services of “all other persons engaged in work that could make us liable.” These “other persons” are referred to as nonemployee labor.
It is important for employers to realize that the various types of nonemployee labor can have different impacts on workers compensation coverage and cost, with variations across states.
How does workers compensation apply to contract labor?
Contract labor is a type of nonemployee labor that closely matches a traditional employee. A contract laborer is someone who, while not being on a traditional payroll, still works under the direct supervision and control of the company hiring them. They are usually provided with all necessary tools and materials, although some may bring their own tools and receive instruction directly from the insured.
Because contract laborers work under your control, they are treated like employees for the purposes of workers compensation even if they receive a 1099 or are paid in cash.
Include their pay in your payroll estimates at policy inception. If this payroll is not included, it will be added during the policy audit, which may result in additional premium due. If injured, they receive the same statutory benefits as W‑2 staff.
How the worker is paid (hourly, per job, check, EFT, cash) does not determine coverage under the standard workers compensation policy.
Payments made to contract labor should be included in payroll estimates at the time of policy inception. Because of contract labor’s lack of independence, they qualify for benefits under the standard workers compensation policy if they are injured on the job.
How does workers compensation apply to independent contractors?
An independent contractor is an independent business or individual hired by an employer to perform work they do not usually perform. They may be paid similarly to contract labor; however, the key difference is their independent status.
Rules governing what makes a contractor independent can vary from state to state but the vast majority revolve around the following main concepts:
- Free from control - The worker is free from the control and direction of the hiring entity.
- Outside of the usual course of business - The work is performed outside the usual course of the hiring entity’s business. This requirement can differ sharply from state to state.
- Independently established trade - The worker is engaged in an independently established trade or business.
- Independently established entity - The contractor hired may be a corporation or an LLC registered with the state and not an individual or partnership.
- Billing practices - The contractor bills the hiring entity and is paid for each job performed.
- The presence of their own hired employees - The contractor has one or more of their own employees that they compensate for working for them.
There are other concepts that may vary from state to state, and some require that the contractor satisfy all requirements to be recognized as independent, while others may be more lenient. It is critical that a company be familiar with the laws of all the states where they may hire subcontractors to ensure proper compliance. IRS or federal criteria for independent subcontractor status is not decisive for workers compensation purposes/classification and should not be relied upon.
Action steps to ensure that a hired independent contractor is properly insured
- Verify independence using your state’s criteria, not the IRS test.
- Require they provide a standard ACORD certificate of insurance that clearly lists the policy number, insurance company and the dates of coverage.
- Add uninsured contractor pay to payroll if proof of coverage is missing.
If a contractor is deemed independent, they must also provide proof they are properly insured.
If an independent subcontractor has employees of their own, they must provide documentation showing proper workers compensation coverage for those employees. Otherwise, uninsured contractors and their employees may be covered under the hiring company’s policy, and payments to these contractors must be included in payroll.
Are service providers covered by your workers compensation policy?
Service providers are independent companies or individuals hired to perform work outside the normal scope of the hiring company’s operations. Accountants, cleaning services, lawyers and outside mechanics are some examples of service providers. Service providers are truly separate and independent businesses that provide various services for a company. Payments to them should not be included in payroll estimates.
Using nonemployee labor is an important part of how many businesses conduct their operations, yet misclassifying nonemployee labor can lead to unexpected higher premiums and leave organizations exposed to unexpected claims.
When hiring nonemployee labor, it is important to know the differences between the various types of nonemployee labor in order to understand their impact. Implementing a regular review cycle can help protect workers and margins.
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By Mark R. Larsen – Underwriting Officer on the Workers Compensation Product Team.
