Workers Compensation Insurance for 1099 Contractors

Workers’ compensation insurance is a must-have for employers; in fact, it’s the law in every state. While it may be clear that you have to carry a policy that covers all employees it can get confusing if you also use independent contractors, also known as 1099 contractors, in your business.

Since independent contractors are not direct employees of your company you may feel comfortable ignoring them when it comes to your workers’ compensation insurance policy. That’s not the best practice, and you may be setting yourself up for a big fine if you’re inadvertently leaving someone off the policy that should in fact be covered.

There are three factors you should clarify if you use 1099 workers in your business. First, you should understand exactly what an independent contractor is. Secondly, you should be aware of the specific criteria that defines who is and is not considered an employee under your state’s workers’ comp laws. Third, you should learn how to avoid misclassifying employees as contractors.

By learning how to identify 1099 contractors in regard to your workers’ compensation insurance policy you can avoid the risk of not having workers’ comp for every person that should be covered. That will keep your workplace safe and help you avoid the costly fines that are levied when a workers’ comp violation is filed against your business.

What is an Independent Contractor

You may be surprised to learn that when it pertains to workers’ compensation the definition of an independent contractor is not the same as what the Internal Revenue Service (IRS) says it is. In fact, it may vary depending on what state your business is in. Here are the criteria for determining independent 1099 contractors in Washington State:

In Washington State, there is a set of six rules used to determine whether a worker is considered an independent contractor or an employee under workers’ comp law, with an additional rule for construction workers. This test is titled RCW 51.08.195 and is known as the six-part test for determining if an independent contractor is exempt.

First and foremost, they must pass the “Personal labor test” which basically determines who calls the shots. If a person brings their own work crew and is responsible for directing their work then they are independent and you should continue the checklist of rules. On the other hand, if your business is responsible for directing the contractor or her workers they are considered employees and should be listed as such under your workers’ comp policy.

The second criterion in the test is whether the contractor brings more than common hand tools to complete the job under contract (and is solely responsible for directing their workers). Examples are landscapers, painters, and flooring installers: all use specialized tools; therefore, they don’t meet the requirements of this test and are not your employees under workers’ comp law.

If the contractor has met the previous rules they must also be a business specifically different than yours, do a specifically different type of service than your company, and had an established business location before you contracted them. In addition, they must file business tax returns with the IRS, be fully licensed and hold an open Department of Revenue (DOR) account, and have been maintaining a separate set of books or records that reflect all items of income and expenses of the business. Construction contractors have an additional rule: they must show proof of their contractor registration.

As you see, there’s quite a difference between the IRS definition of a 1099 contractor and the workers’ compensation definition if you live in the state of Washington. This is a broad description of the rules and does not give all the details of each rule.

Some states have nine step criteria for determining independent contractors but most are similar to those outlined above. The main thing to remember is to not only run each new contractor through the checklist but also each new contract. That way your business is covered regardless of the circumstances.

Some of the other factors that are considered are:

  1. Does the worker have the ability to hire help and to control those helpers?

  2. How does the firm pay the worker by the hour, day or job?

  3. Is the worker reimbursed for expenses?

  4. Is there a written contract?

  5. Are there set hours of work?

  6. Tools and equipment are furnished by whom?

  7. is there insturciton as to how, when, and where to do the work? or how the work is actually achieved?

  8. Is any training provided by the firm? ( Most independent contractors use their own methods and receive no training.)

  9. Does the worker have the option to decline work/assignments or does the firm have priority on workers time?

  10. Does the firm have the right to direct how the work is done, regardless of whether they exercise that right?

Remember, Joe the builder may have been doing your renovations perfectly for nine years but that doesn’t mean he’s making his workers’ comp premium payments in a timely manner. Always get the required proofs each time a new contract is signed.

Who is an Employee under Workers’ Compensation law

Again, we’ll use Washington State as our example for determining who is an employee. Basically, anyone who receives something of value for time worked is considered an employee under the workers’ compensation insurance law, which is why the test for determining 1099 contractors is so strident. Because the IRS independent contractor law is not a valid determination for workers’ comp insurance the person in charge of this insurance should become very familiar with the step-by-step 1099 rules regardless of which state you live in. This is the only way you can be sure your business is in compliance with the state workers’ compensation laws in determining who is or isn’t an employee. Here are some examples where you might think the person is exempt when in fact they should probably be included in coverage:

  • A volunteer worker who receives product in exchange for their work

  • An unpaid trainee

  • A paid intern

  • A minor working in her parents’ grocery store

On the other hand, aside from 1099 independent contractors there are certain workers who can be employees but are not required to be covered under a workers’ comp policy. Here are some examples:

  • A single domestic worker employed less than 40 hours per week

  • A minor child employed in agricultural activities on the family farm

  • A barber or cosmetologist who rents booth space at your business

For the most part if someone is performing work for you they should be covered under your workers’ compensation insurance. Adding a new employee to the policy should be part of your hiring procedure as it protects your business as much as it protects the worker.

In certain cases, such as sole proprietorships, partnerships, and corporations the business owners can opt out of coverage for themselves and board members. Again, this should be considered in a case-by-case scenario to determine what is best for your own company. There are specific rules and some exclusions and limits on coverage for these types of business owners.

If you’re bringing workers in from another state where they have workers’ comp insurance already in place you should check for compliance issues with the state you are in. You may need to sign a statement of reciprocity or may have a time limit as to the period the out of state coverage will be acceptable.

Misclassifying Employees as Contractors and how and why to Avoid this (including fines)

f you misclassify an employee as a contractor you can end up paying some hefty fines, which is why the six-part RCW 51.08.195 test is so vital when signing on a would-be contractor.

To avoid misclassifying employees as contractors the person in charge of hiring must be well-versed in the six-part test and should always verify the specific proofs have been submitted before the contract goes into effect. Here are some scenarios your company could face if the hiring or payroll manager were derelict in gathering the proofs required:

First scenario: Your neighbor’s son is home from college and has convinced you to hire him “under the table” so he doesn’t have to pay taxes on his income. He falls and breaks his arm while working in your warehouse. Possible consequences:

  • You have to pay all his medical expenses out of pocket

  • He sues your company for damages

  • Your business may face an additional fine equal to at least half, but not more than 100 percent, of the cost for the injury

  • Fines up to 10 times the amount of the difference between the premiums that the employer paid and the amount it should have paid

  • The state’s expenses for auditing the employer’s books and collecting the penalty.

Second scenario: You hire a contractor and when one of his crew is injured at your place of business you find out the contractor is not up to date on his workers’ compensation insurance premiums. Possible consequences:

  • You may be liable for the independent contractor’s unpaid premiums because you failed to get proof of coverage

  • You may be open to a lawsuit from the worker

  • You may be fined up to $250.00 or 200 percent of the quarterly tax for each such offense, whichever is greater.

As you see, the consequences of just a single violation can be expensive and far-reaching.

Here are some of the broader examples of the landscape of workers’ comp insurance and its violations.

There were 10.3 million independent contractors in the total workforce in 2005, growing from 6.7 percent of the workforce in 1995 to 7.4 percent in 2005, mostly in construction services.

A 2007 Staffing Buyers Survey estimates that the contingent workforce is expected to grow to 10 percent of the entire U.S. workforce within two years. According to the survey, 77 percent of companies expect to grow their contingent workforce.

A 2004 study by Harvard researchers for the State of Massachusetts is one of the few state studies focusing on workers’ compensation. They found unpaid workers’ compensation premiums of $91 million a year due to independent contractor misclassification; $7 million of those unpaid premiums were in construction. This touched off a legislative call for a special study commission.

A 2007 study by the University of Maine examined the extent to which employers in the construction industry misreported employees as independent contractors. That study, based on an earlier survey by Harvard, estimated that 11 percent of Maine’s construction workers were misclassified as independent contractors.

A study done by University of Missouri–Kansas City researchers found an 18 percent rate of misclassification in Illinois.

New Jersey’s Labor Department audits about 2 percent of employees for unemployment insurance, and in 2005 it found more than 26,000 misclassified.

A 2007 report by Cornell University estimated that 704,000 private-sector workers had been wrongly classified as independent contractors, and at least 39,500 employers mislabel workers annually. Conservative estimates suggest that between 500,000 and 1 million New York workers who should be covered by workers’ compensation are not. To put this in perspective, approximately 10.3 percent of private-sector workers are misclassified as independent contractors (about 14.8 percent in construction)

Risks of not having Workers’ Comp

The biggest risk of not having workers’ comp because you didn’t realize a contractor was in fact considered by the state to be your employee is that the worker may become injured and there will be a gap in treatment because there is confusion about coverage.

The second biggest risk is that you may lose your business because of it. Penalties and fines are heavy when it pertains to workers’ comp violations, and if a worker is injured or killed without proper insurance your business will be responsible for the medical costs incurred. In addition, they or their survivors will have the right to sue you in a civil court, which means you may lose the company itself.

Workers’ compensation insurance violations can carry legal consequences including felony charges, and typically each following violation found is fined at a higher rate than the previous violation.

Remember, even though your independent contractor has met all the criteria as outlined by the state it will still fall to your own company to be in compliance while they’re working at your business. That means you must verify all information submitted and have the corresponding paperwork on hand if it’s required by law.

Even though you may assign the oversight of workers’ compensation requirements to another worker the bottom line is that if your company is audited or there’s and accident and a violation is found it is the business that will be penalized. That’s why workers’ comp training is so vital to a smooth running and successful business

Hiring independent contractors can be a big savings to your company but it is vital that the person in charge of contracts be well educated in the state laws regarding workers’ compensation insurance.

The rules in place for determining whether an independent contractor is in fact an employee are not the same rules used by the IRS. In fact, they are different in each state. Because a claim of ignorance is not a legal defense your payroll or hiring manager (or ideally, both) should be well versed in the legal requirements for using independent contractors.

Your company should have a checklist in place for 1099 contractors as well as an up-to-date filing system to keep track of the records each contractor submits with their contract.

Each contract should be treated separately, even if you’ve used the same contractor a hundred times. That way your paperwork will be up to date and you’ll have proof that they have paid their workers’ comp premiums in a timely manner and all the workers on your premises are covered in case of injury.

Once you have a checklist and system in place you should make sure it stays up to date. Keep up on any changes in the state laws regarding workers’ compensation insurance and implement the changes in a timely manner.

It’s a good idea to set up an annual refresher course for the persons in charge of hiring as well as workers’ compensation insurance so they keep abreast of any changes. Every state has educational materials available that can be used in any size or type of business.

While workers’ compensation insurance can be confusing when you use 1099 subcontractors once you get the proper training and system in place you’ll have a safer, smoother running business because of the preventive steps that are in