Workers' Compensation Payroll Audit
Your workers' compensation premium is an estimate at policy inception. The final premium is determined afterward, by audit of your actual payroll, conducted at least annually. Carriers may audit within three years after the policy period ends.
Premium is calculated as payroll ÷ 100 × rate, then adjusted for experience modification, schedule rating and premium discount - with the expense constant added separately and not subject to any of those adjustments.
Which makes one question worth an enormous amount of money: what counts as payroll?
What's included
- Wages and salaries
- Commissions and draws against commissions
- Bonuses, including stock bonus plans
- Overtime - but see the premium rule below
- Pay for holidays, vacations and sickness
- Employer payment of amounts that would otherwise be withheld to meet statutory obligations
- Piecework, profit sharing and incentive plans
- Rental value of housing provided to an employee; value of other lodging received as pay; value of meals received as pay
- Store certificates, merchandise, credits, or any other substitute for money
- Employee salary-reduction contributions to savings plans, retirement plans and cafeteria plans
- Prevailing wage compensation
- Unverified expense allowances
What's excluded
- Tips and other gratuities received by employees
- Employer payments to group insurance or group pension plans
- Employer contributions to savings plans, retirement plans, cafeteria plans, health savings accounts and flexible spending accounts
- Dismissal or severance payments, except for time worked or vacation accrued
- Third-party sick pay - paid by an insurer rather than the employer
- Payments for active military duty
- Special rewards for individual invention or discovery
- Employee discounts on the employer's goods
- Verified expense reimbursements - requiring documented business purpose, itemised records, an amount approximating the actual expense, and payment that supplements rather than replaces wages
- Per diem up to $75 per day where overnight business travel is verified but daily receipts aren't
- Supper money for late work; work uniform allowances
- Company vehicles, flights, club memberships, event tickets, educational assistance, relocation expenses
- Deferred compensation distributions to retired or terminated employees
The two distinctions that cost the most money
Tips are excluded - mandatory service charges are not. The test is customer discretion. A tip is excluded because the customer decides the amount and decides the employee receives it. An automatic gratuity or service charge added by the establishment is included in payroll, because the customer decided neither.
Employer contributions are excluded - employee salary-reduction deferrals are included. The same cafeteria plan produces both. The employer's contribution comes out of payroll; the employee's own pre-tax deferral stays in. This is regularly reversed in practice, in both directions.
The overtime premium rule
The excess portion of overtime - the "half" in time-and-a-half - can be excluded, but only if your records support it.
- If records show overtime pay separately by employee and in summary by classification, the entire extra pay is excluded.
- If records show only combined total pay for overtime at time-and-a-half, one-third of that total must be excluded.
- For double time recorded separately, one-half of the total is excluded.
There's an exception for payroll assigned to certain stevedoring classifications.
Practical translation: the exclusion is available if you can prove it and unavailable if you can't. Payroll that reports a single blended overtime figure gives up the exclusion or falls back to the one-third rule.
The recordkeeping failure that costs the most
If your records do not permit proper division of an employee's payroll between classifications, the entire payroll of that employee is assigned to the highest rated classification. And estimated or percentage allocation is not permitted.
An employee splitting time between a low-rate clerical classification and a high-rate operational one gets charged entirely at the high rate unless contemporaneous records show the actual division. This single rule generates more unexpected audit bills than any other.
Officers, partners and LLC members
Executive officers - president, vice president, secretary, treasurer, or any other officer appointed under the charter or bylaws - have premium based on total payroll, subject to a minimum and maximum individual payroll published in each state's values, applied to average weekly payroll for the weeks the person was an officer and prorated for partial periods.
Officer payroll is included where the officer visits premises without performing duties, attends meetings while taking an active interest, or has salary credited but undrawn - and where no salary is drawn, the minimum applies. It's excludable only where the officer was elected in name or stock only, performs no duties, and doesn't visit the premises.
Partners, sole proprietors and LLC members aren't normally employees but may elect coverage. Payroll for each is a flat amount published in the state's values - not their actual draw.
(Illustrative figures from one state, effective April 2025: officer minimum $1,200 and maximum $2,400 weekly; partners, sole proprietors and LLC members $62,900 annually; expense constant $160. These vary by state and change annually.)
Subcontractors
Obtain evidence that each subcontractor carried workers' compensation insurance - a certificate of insurance, or a certificate of compliance for a self-insured sub.
Where an uninsured subcontractor's actual payroll records aren't available, the minimum payroll charged to you is:
| Contract type | Minimum charged |
|---|---|
| Labor and material | 50% of the subcontract price |
| Labor only | 90% of the subcontract price |
| Piecework | 100% of the subcontract price |
And uninsured subs are classified as if the work had been done by your own employees - potentially at your highest rate.
The experience modification factor
Adjusts premium to your own loss history. Below 1.00 is a credit, above 1.00 a debit - a 1.20 mod predicts losses 20% worse than the average employer in the same classification.
Mechanics worth knowing:
- The experience period covers roughly three years - policies effective 21 to 57 months before the rating date. The current policy year is excluded, so today's safety improvements won't show up for two years.
- Losses are split into primary (frequency-weighted) and excess (severity) components.
- Medical-only claims are reduced by 70% - only 30% flows into the mod. Which is why closing a claim as medical-only rather than letting it become lost-time matters enormously.
- Credibility rises with employer size.
- The mod is calculated 60 to 90 days before renewal, and data must be reported within 18 months of policy inception.
If you don't cooperate with the audit
Non-cooperation can trigger an audit noncompliance charge - a multiple of the estimated annual premium.
The multiplier is state-specific. Up to two times estimated annual premium under the national rule; up to three times in at least one state; removed entirely in Massachusetts; never adopted in Indiana, where carriers pursue collections instead.
The carrier must make two documented attempts to obtain the information, notifying you each time of the records required and the charge amount. If you subsequently permit the audit, the charge is refunded or applied to an outstanding balance. Non-cooperation can also result in cancellation of coverage.
Who sets the rules in your state
Most states use the national rating organisation's classification system. Eleven states have independent rating bureaus: California, Delaware, Indiana, Massachusetts, Michigan, Minnesota, New Jersey, New York, North Carolina, Pennsylvania and Wisconsin.
Texas is not one of them - a common error. Texas uses the national organisation's loss costs with carrier-specific multipliers, though it does use Texas-specific classifications that can differ significantly from other states.
Four monopolistic states - Ohio, North Dakota, Washington and Wyoming - where coverage comes from the state fund rather than private carriers, with narrow statutory exceptions in Ohio and Wyoming.
Frequently asked questions
Why did we get a bill after the policy ended?
Premium is estimated at inception and settled by audit against actual payroll.
Are tips included in payroll?
No - but mandatory service charges and automatic gratuities are.
Can we exclude overtime premium?
Yes, if records show overtime separately by employee and by classification. Otherwise one-third of time-and-a-half pay is excluded.
Are 401(k) contributions payroll?
The employee's salary-reduction deferral is included. The employer's contribution is excluded.
What if an employee works in two classifications?
Keep records supporting the division. Without them, the entire payroll goes to the highest rated classification, and percentage estimates aren't accepted.
What happens with an uninsured subcontractor?
You're charged for their payroll - a minimum of 50% to 100% of the subcontract price depending on contract type.
What if we don't respond to the audit?
An audit noncompliance charge of up to two or three times estimated annual premium, depending on the state, plus possible cancellation. It's refunded if you later permit the audit.
This guide is general information about reporting requirements, not legal advice. Verify current deadlines, thresholds and penalty amounts against the issuing agency before you file.