What Payroll Is Included in a Workers Compensation Audit?

Workers’ compensation insurance protects businesses and employees by covering medical costs and lost wages for work-related injuries or illnesses. At the end of a policy term, usually annually, insurance providers conduct a premium audit. This audit verifies actual payroll and employee classifications to ensure the business paid the correct premium. Understanding which payroll elements are included in this calculation helps businesses manage their insurance costs.

Understanding Includable Payroll

Workers’ compensation premiums are largely based on the remuneration paid to employees, as this compensation represents the business’s exposure to risk. Standard wages and salaries, including any retroactive payments, are included in payroll calculations. Commissions and bonuses, whether performance-based or stock-related, also count toward includable payroll.

Overtime pay is generally included, but often only the straight-time portion of the earnings is considered, not the additional overtime premium. For example, if an employee earns $20 per hour and receives time-and-a-half for overtime ($30/hour), only the initial $20 per hour for all hours worked would be counted. Vacation pay, holiday pay, and sick pay are also included. Payments for piecework, profit-sharing, or incentive plans are also included. Non-cash compensation, such as the value of lodging, meals, or car allowances provided to employees, can also be part of includable payroll.

Common Payroll Exclusions

While many forms of compensation are included, certain types of payments are generally excluded from workers’ compensation payroll calculations. Tips and gratuities are typically not included. Employer contributions to employee benefit plans, such as health insurance premiums, qualified retirement plans like 401(k)s, or cafeteria plans, are usually excluded.

Reimbursements for legitimate business expenses, provided proper records, are also excluded from payroll. Severance payments are generally excluded, except for any portion that represents accrued vacation or time worked. Per diems for travel and payments for active military duty are also excluded. Employer contributions for FICA (Social Security and Medicare taxes) are not part of the payroll calculation. Payments made to properly classified independent contractors who maintain their own insurance coverage are excluded; however, if a contractor lacks their own coverage, their payments might be included in the business’s payroll during an audit.

Role of Employee Classification in Audits

Employee classification is a significant factor in determining workers’ compensation premiums. Different job duties carry varying levels of risk, and these risks are reflected in specific classification codes. The National Council on Compensation Insurance (NCCI) develops and maintains these codes, typically four-digit numerical codes, each representing a particular business or job type.

Each classification code has an associated rate, based on the inherent risk of the work performed. During an audit, payroll figures are assigned to these codes based on the employee’s actual job duties, not just their job title. Accurate classification is important because misclassification can lead to incorrect premium calculations, additional premiums, or penalties. Conversely, over-classifying employees can result in overpaying for coverage.

Preparing Required Documentation

Preparation is important for a smooth workers’ compensation audit. Businesses should gather and organize financial and employee records for the audit period, which typically covers the previous policy year. Essential documents include payroll journals and general ledgers.

Federal tax forms, such as Forms 940 and 941, are crucial for verifying total payroll. Individual employee earnings records, time cards, and overtime pay records are also needed to reconcile compensation. For independent contractors, payment records like Form 1099-NEC and certificates of insurance proving their own workers’ compensation coverage are necessary. Clear job descriptions for all employees help auditors verify appropriate classification. Maintaining these records accurately and consistently throughout the year can simplify the audit process.

Navigating the Audit Process

Once documentation is prepared, the audit process typically begins with a notification from the insurance company. This notification usually outlines the required documents and the method of audit, which can be on-site, by mail, or virtual. During the audit, the auditor reviews financial records to reconcile the estimated payroll with the actual payroll figures.

The auditor also verifies that employee classifications accurately reflect the work performed and may ask questions about business operations or employee duties. The goal is to ensure the premium charged aligns with the actual risk exposure. After the review, the insurance company issues an audit statement, which may result in an additional premium due if payroll was underestimated or a refund if it was overestimated. Businesses have options to dispute audit findings if they believe there are inaccuracies, typically by providing a written explanation and supporting documentation to the insurer.