Do You Need Worker's Comp for Independent Contractors?
Updated: Mar 29
If you are running a business, it means you probably have some employees. If you have employees you are generally required to purchase workers compensation insurance. To avoid this mandate, a number of employers simply classify someone as an “independent contractor.” Misclassifying an employee deliberately is considered workers comp fraud and the employer can be subject to penalties and fines.
Common Fraudulent Practices
There are several ways employers attempt to avoid obtaining workers comp insurance. If you are in this boat, it’s okay. We aren’t going to rat on you. We will, however, encourage you to start taking corrective action and properly insure your employees.
Typical steps employers take to avoid paying workers comp include:
Simply not buying the required insurance
Incorrectly classifying someone as an independent contractor
Incorrectly paying the party via 1099, and not a W2
Forcing parties to sign independent contractor agreements
The bottom line is employers should act in a responsible and ethical way. If someone is an employee, buy the required insurance as well as accurately report the information on your payroll when applying and renewing your policy. Courts have been keen on noticing these tricks to “avoid” workers comp. Insurance carriers have also begun increasing audits to ensure all rules and regulations are being followed.
How to Determine if an Employee or Independent Contractor?
When making the determination if a worker is an employee, the court generally looks at the issue of “control” an employer has over someone. While each court and state may interpret things differently, some general ways to analyze if someone is an independent contractor include:
Stays separate from business office and equipment:
An independent contractor should not be headquartered or have an office within the employer’s usual place of business. Instead, independent contractors should have a separate office and use their own equipment and tools to perform job duties.
Separate federal employer ID number:
Independent contractors should have their own separate federal employer tax ID number. Never believe that just because payroll taxes are not withheld makes someone an independent contractor.
Contract agreement where independent contractor controls the means of performing the service:
When hiring an independent contractor, a contract will outline the terms of service. Be careful to draft the agreement in a way that does not take away the contractor’s performance discretion. The contract should avoid control. Even by outlining a start/end time and mandatory breaks may tip the scales toward claiming to be an “employee.”
Business expenses paid for:
Independent contractors will generally be required to pay for all business expenses out of their own pocket. Once the employer starts paying for materials or parts needed to complete a job, courts tend to favor considering that person as an employee. However, the employer is allowed to reimburse the independent contractor for expenses during or at completion of a project.
Responsibility of completion under the contract:
An independent contractor must ensure completion of project but at their own discretion. This means an independent contractor can subcontract or outsource some of the work. Employers should protect themselves by ensuring all parties have their own workers comp insurance before entering the job site. Some states hold the employer as liable in terms of workers compensation.
Gets paid via commission or on a per job basis:
Independent contractors should be paid either by commission or by the project/job. Paying someone an hourly wage generally signifies that his worker is an employee. Independent contract work is usually specified work. Once the work becomes broad, courts may view that worker as an employee.
No guaranteed profit:
A party that is guaranteed to make money will be considered an employee. It is the element of risk that separates employees from an independent contractor. For example, an employer may make a contract with an independent contractor to build a deck for $5,000. It is up to the independent contractor to build in a profit margin on that $5,000 contract. If the independent contractor underestimates the time and labor needed to complete the job, they are on the hook.
Some independent contractor work can become repetitive and repeat itself. An independent contractor can work in the same manner or job once one is completed. Employers can get into trouble if the relationship ends up being “show up to work tomorrow and we’ll find something for you to do.” This illustrates that person as an employee.
Independent contractors are widely used and essential for many businesses and industries. Employers should be responsible in purchasing workers comp insurance for their employees. Any misclassification or attempt to not purchase workers compensation insurance is considered fraud by courts and can lead to penalties and fines.
Partnering with a PEO like CornerstonePEO may be in your best interest. CornerstonePEO is a nationally renowned workers comp expert. Our industry leading PEO services offer innovative, cost effective, easy to understand business solutions for companies of any size and industry. Contact us to learn more or a FREE consultation.