2012-08 Newsletter_Nightingale

Help Your Clients Avoid Two Common L&I Audit Findings

By Celia Nightingale
Small Business Liaison for the Department of Labor & Industries

Given the breadth of their responsibilities and demands on their time, it’s easy to understand how business owners can lack full knowledge of the regulations that affect them.  Unfortunately, that knowledge gap can be costly. As L&I’s Small Business Liaison, I get calls from unhappy businesses after auditors found they owed additional workers’ compensation premiums, plus penalties and interest. Those businesses wished there had been a less painful way to learn the rules.

Two particular areas are often misunderstood: workers’ comp risk classification and independent contractors. The issues are detailed below, with my request that you help educate your clients to avoid these common mistakes.

Workers’ Compensation Risk Classification

As you likely know, L&I assigns one or more risk classifications for reporting worker hours, with the cost of workers’ comp insurance reflecting the risk of injuries affiliated with the assigned class. Some issues that arise with risk classification include the following.

Business change and growth

Businesses evolve, which can lead to new products and services, mechanization and increased employee specialization. Changes could result in different or added risk classes. Each business has an L&I account manager assigned to it, and that is the person to contact to discuss if classification changes are warranted. See L&I’s Rate & Risk Classes webpage for more information.

Exception risk classes

If a business is assigned more than one basic risk class, employee hours can be divided between classes, reflecting the work they do. Examples may be a general contractor whose employees are framing during one period, doing interior finish carpentry another, and painting another.   

Exception risk classes are different. If a business is assigned an exception class, employees reported under that class must ONLY work in that class during the entire reporting quarter. Otherwise, the employees’ hours must be reported entirely under the appropriate basic risk class(es). The four exception classes are:
  • 4904-Clerical/Office
  • 6101-Vehicle & Boat sales
  • 6303-Outside Sales
  • 7101-Corporate Officers
Common situations that would prevent use of an exception class would be an office worker who is asked to bring materials to a job site, a sales rep that helps delivery staff on occasion, or a corporate officer who chips in on the production floor to meet a deadline. Because of what could be a significant impact on workers’ comp costs, a business might be better off using temporary or part-time staff to fill in those needs rather than using exception classification staff to help out. See the “Standard Exception Classifications” publication for more information.

Required time records

Because workers’ comp is calculated on hours worked, accurate timesheets are critical. This is especially true for businesses that report under two or more risk classifications. To meet recordkeeping requirements, timesheets must reflect work dates, start times, stop times, and the appropriate risk class. They should be signed by the worker and supervisor. In the absence of credible timesheets, L&I’s auditors calculate premiums due, assuming full-time hours at the highest risk class.

The drywall risk class is unique*. Workers’ comp premiums for drywall workers are based on square footage of material purchased and installed. Therefore, in addition to good time records the business must keep drywall purchase records (or receipt records if materials are supplied by another contractor).  If the owner works in the business, he/she must keep accurate timesheets for him- or herself.  The timesheets are required to either: 1) support a deduction in the total drywall used in the premium calculation if the owner has not elected to be covered for workers’ comp; or 2) be included as one of the required employment records if the owner has elected coverage (and has completed the required optional coverage application form).

*Other classes with unique recordkeeping requirements are taxis/limos, reforestation, mechanized logging, and trucking.

Independent Contractors

Another area of frequent audit findings is with regard to independent contractors). Washington law is very strict regarding which individuals can be exempted from workers’ compensation coverage requirements. Independent contractors who can meet the IRS test won’t necessarily meet L&I’s.  

Independent Contractor Test

The Washington Law (RCW 51.08.195) includes a 6-part test, with a 7th part for construction contractors: that they be properly registered as general or specialty contractors at the time they performed on the contract.  

If a contracted firm brings its own employees or major equipment to a job, it will generally pass L&I’s test. “Major equipment” would including such things as front-end loaders, semi trucks, medical scanners, etc.; not hand tools. But if an owner of the contracted firm is doing the work him- or herself, no matter the level of expertise and training he or she may possess, it may not meet the test. It doesn’t matter how the firm is structured (i.e. sole proprietorship, partnership, corporation, LLC).  

Evidence to Support Independent Contractor Status

Some records your clients may want to gather to support their determination that contracted firms meet the independent contractor test include:

  • Evidence that the firm brought major equipment or employees, if applicable
  • A formal contract that:
    o Spells out the independent relationship
    o Doesn’t impose restrictions, such as a noncompete agreement or specifics about how the work is to be done
    o Doesn’t allow termination at-will (though may provide recourse for breach of contract)
    o Reflects the true relationship. L&I auditors interview independent contractors to verify their independence. The law states that the individual must be free from direction and control, both by contract and in fact, so if the contractor states that the business exercised control, even if the contract says otherwise, it may be determined that the business should have covered the independent contractor for workers’ comp
  • Proof that the business is actively marketed and serves multiple clients
  • Formal invoices, ideally billing for part or all of a contracted price rather than for hours worked
  • Proof that the business
    o Has an active Department of Revenue account
    o Keeps its books (income, expenses, etc.) and can suffer a loss
    o Files a business tax return with the IRS
    o Has an IRS-deductable business location
    o If applicable, is properly registered as construction contractor
Because of L&I’s audit time periods, it may be up to four years after the business used the services of an independent contractor that it would be asked for documentation supporting the independent relationship (three calendar years plus year-to-date).

In law, it’s the business’s obligation to prove that the independent contractor was truly exempt from workers’ compensation requirements, not L&I’s to prove otherwise.

Special Issues with General Contractors and their SubContractors

The same issues noted above apply to general contractors and their subcontractors as well, so making the case that subs are independent contractors requires the same types of evidence. Typical auditor concerns include whether the subcontractor’s specialty is outside the general’s “usual course of business” (per RCW 51.08.195), whether the work was performed under the general’s supervision, and concerns related to “place of business."

I welcome your questions and comments!  You can reach me at [email protected], www.SmallBusiness.lni.wa.gov, 360-902-4865 or 800-987-0145.