We opened this series on Triggers vs Findings of Fact with an overview of why US state and federal governments (tax authorities, various agencies, and not just in the US) are so focused on reducing the occurrence of employee misclassification and are investing heavily on increased enforcement.

To summarize, it is primarily the lost tax revenue that has captured and retained their attention. 

What we introduce in this issue is the other side of the government’s lost tax revenue equation: the savings employers try to capture by classifying workers as independent contractors. 

As noted earlier, engaging a worker as an independent contractor instead of as an employee means the company does not have to pay employer payroll taxes, does not have to withhold and file employee taxes, and does not have to offer and provide employee benefits (i.e. health insurance, 401k, holiday / vacation / sick pay, etc.). In other words, companies can legitimately avoid these costs altogether when compliantly engaging the worker as an independent contractor. 

Caution: The government does not take your opportunity for savings into account when evaluating classification determinations and neither should you or your company!

Employer payroll and benefits are not the only material costs some employers are trying to avoid when engaging workers as 1099 independent contractors: for some companies, workers’ compensation insurance premiums represent another material cost bucket, in addition to payroll taxes and benefits. 

The Cost of WC Insurance is High

Workers' compensation insurance is generally a state-mandated safety net exclusively for employees.

The insurance covers medical bills and lost wages when the employee suffers a work-related injury.

Independent contractors aren't covered by the client’s WC policy as they are expected to manage their own risks.

The premiums employers pay for this insurance are indeed costly, but the coverage the policy provides also protects the hiring company from direct lawsuits from injured workers and direct liability for their medical expenses and lost wages. 

WC premium rates depend largely on the type of work the worker will be performing.

The industry has adapted the use of WC codes (more detail below), an industry standard that assigns a level of risk to the work being covered.

By way of illustration, here are a few WC codes and general estimates of the associated insurance costs that we found online, represented as a cost per $100 of payroll paid to the workers.

• Low Risk - WC Code 8810 - Clerical Office Employee: $0.11 - $0.32

• Moderate Risk - WC Code 8017 - Retail Store / Merchandiser: $1.23 - $2.63

• High Risk - WC Code 5403 / 5645 - Residential Carpentry: $5.46 - $9.09

• Very High Risk - WC Code 5551 / 5552 - Roofing: $12.34 - $87.83

The potential high cost is why some companies are tempted to avoid having to obtain WC insurance altogether by hiring workers as independent contractors instead of as employees.

But doing so is extremely risky: a misclassified contractor that suffers a work-related injury can explode into a significantly more costly legal and financial disaster for the company that far exceeds the WC insurance cost.   

The Problem: When Injury Exposes Misclassification

But what happens when a worker you pay via 1099 gets seriously hurt performing their duties for your company?

Even if they were properly screened and classified as an independent contractor, the high cost of a serious injury could put the worker in a position where they feel they have no option but to file a workers’ comp claim.

Most states do not require independent contractors to carry their own workers’ compensation coverage.

The states only mandate coverage for “employees” of the company. So if the “independent contractor” you hire is not an “employee” of their IC business (i.e. like if they are a C or S Corp), then there is no WC insurance requirement.

That helps narrow the problem statement: when injury exposes misclassification of uninsured independent contractors.

The reason WC coverage and IC classification is such a toxically dangerous combination is the fact that Independent contractors can still file a claim with the state workers’ compensation commission.

And this leads us back to our topic: contractor led triggers to misclassification inquiries and claims. 

Classification Complexity Enhanced by State Level WC Boards

Any filing by an IC, especially one without their own WC coverage, will likely trigger scrutiny from the state's workers' compensation commission or board.

The WC board won't just take your word on the worker classification status – or even a signed contract stating "independent contractor" – as final.

Instead, they'll investigate the WC claim and in so doing verify or challenge the independent contractor or 1099 classification.

And because each state has its own version of a workers’ compensation commission or board, the specific legal tests applied to make the classification determination vary significantly by state.

In other words, in some states the legal test for determining independent contractor status may be the common law "right-to-control" test while in other states it may be the much stricter "ABC" test to determine the actual nature of the working relationship.  

State Courts Look Past the IC Label

There are a number of rulings that underscore the point that the reality of the relationship (i.e. management practices, direction and control behaviors, supervision, uniforms, emails, etc.), not the label, is what the courts look at for deciding employee status for workers' compensation. Here are two examples:

1. Waste Management of Texas, Inc. v. Stevenson (2021). Despite a contract explicitly labeling him an independent contractor, Texas Supreme Court found that the injured worker, who was provided by a staffing agency, was instead a Waste Management employee for the purposes of applying workers' compensation coverage. In this decision, the court focused on the company's “right to control” the details of his work.  

   
   

2. Oufafa v Taxi, LLC (2023).  The "economic realities" test was the legal test applied by the Kentucky Supreme Country for determining a driver’s classification for workers' compensation coverage. The driver was classified by the company as an independent contractor. The driver was injured by a passenger during a ride. The Court emphasized the driver’s “economic dependence” on the company based on the fact that the driver leased a vehicle from the company that was usable only for company rides.  

These cases show that factors like control over work methods, integration into the business, and economic dependence often outweigh contractual terms in the eyes of the law. 

The High Cost of Getting It Wrong

If the state determines your "independent contractor" was actually an employee, the potential financial fallout can be severe and could include back premiums for the WC insurance that was initially avoided:

• Direct Liability: You are found to be directly responsible for the contractor’s  medical expenses and lost wages. These are costs WC insurance would have covered.  

• Heavy Penalties: There is a lot of precedent where states are found to impose significant fines for failing to carry required workers' compensation insurance, plus the penalties and back taxes from the misclassification itself.    

• Back WC Premiums & Taxes: It is common for back workers' compensation premiums to be assessed when a reclassification for WC purposes occurs. 

• Broader Audit Trigger:  Often the findings of fact applicable to a worker who filed a single WC claim can be expanded to all other similarly engaged “independent contractors.” This will result in the typical employee misclassification back taxes and penalties, but also now in the back WC insurance premiums. 

Prevention is Priceless

The anticipated savings from classifying workers as independent contractors, can evaporate in an instance when a misclassified worker is injured on the job.

The direct liability for medical and lost wage responsibility, plus the benefits, fines, back premiums, and back payments often far exceeds any initial cost savings a company may set their sites on.

To prevent this avoidable catastrophe from happening to you and your company, be sure to do the following:

• WC Focused IC Screening: Make sure you (or your IC compliance provider) incorporates each states’ WC legal test standards into the classification evaluation of your independent contract workers, before work begins. Additionally, every IC classification screening should include an assessment of the type of work being performed and a WC code assigned. (See next item.)

  
  

• Know Your State’s WC Rules: As noted above, each state has its own set of rules to govern WC insurance requirements and the claims process. It is imperative you know the state level rules for your own state as well as the states where your ICs (employees) reside or are performing their work. For instance, while most states adapt or effectively align with NCCI (National Council on Compensation Insurance) guidelines, not all states utilize the same WC code standards to assess work related risk levels. For a good overview click here.

  
  

• Compliance Readiness Audit: Hire an independent IC compliance service provider to conduct an audit of your company’s internal management practices relative to independent contractor engagements. Identifying classification risk exposures and closing those gaps is the best prevention you can buy. 

  
  

• WC Insurance Requirements for ICs: Remember, most states do not require ICs to maintain WC coverage, but that does not mean you cannot require the ICs to obtain their own WC coverage prior to providing services to your company. Make this a requirement, especially for all moderate - very high risk contractor engagements.

Conclusion

Getting worker classification right isn't just about compliance; it's about protecting your business from a preventable financial catastrophe.

Next Issue

In the next issue of The Compliance Capsule we will transition from our focus on Triggers to a deep dive on Findings of Fact. As we have discussed in prior issues.