Classification Mistakes Are Expensive
How you classify workers has direct insurance consequences. Call employees independent contractors, and you'll face workers' comp audit surprises, potential coverage gaps, and regulatory penalties. Understand the rules to protect your business.
Why Classification Matters
Workers' Compensation
Employees must be covered under your policy. True independent contractors carry their own coverage. When auditors reclassify your 1099 workers as employees, you owe back premium for the entire audit period.
General Liability
Employee acts are automatically covered under your policy. Independent contractor coverage works differently, typically through requiring them to carry their own coverage and add you as additional insured.
Audit Consequences
Auditors review all workers regardless of how you've classified them. They apply legal tests to determine actual status. Misclassified workers get added to your payroll with resulting premium due.
The Legal Tests
Behavioral Control
Do you control how work is done, or just the result? Do you provide training on methods? Do you set work hours and locations?
More control suggests employee status. Independent contractors typically determine their own methods.
Financial Control
Who provides tools and equipment? Do you reimburse expenses? Does the worker have investment in their own business? Can they profit or lose money independent of your payment?
True contractors have their own business investment and bear financial risk.
Relationship Type
Is there a written contract? Do you provide benefits? Is the relationship ongoing or project-based? How do both parties view the relationship?
California-Specific Considerations
California follows federal guidelines but also applies the ABC test under AB 5, which considers how your industry typically operates, the worker's own business activities, and their licensing status.
A licensed plumber with their own insurance, multiple clients, and their own tools is more likely to be a legitimate independent contractor. Someone who shows up daily, uses your equipment, and works exclusively for you is probably an employee regardless of paperwork.
Insurance Requirements by Classification
For Your Employees
Workers' compensation coverage is mandatory. Include them in payroll calculations. They're covered under your general liability automatically.
For True Independent Contractors
Require their own GL policy. Require workers' comp if they have employees or for personal protection. Get certificates of insurance before work begins. List yourself as additional insured.
Protecting Against Misclassification
Documentation Practices
Maintain written contracts defining the relationship. Collect certificates of insurance. Verify contractor licenses. Keep invoices rather than timesheets.
Audit Preparation
Be ready to show all 1099 versus W-2 classifications. Have certificates for all subcontractors. Document evidence of independent businesses. Maintain organized records.
Consequences of Getting It Wrong
Premium Surprises
Workers get reclassified and added to your payroll. Back premiums are assessed for the entire policy period. Interest and penalties may apply.
Coverage Gaps
Injuries to misclassified workers may not be covered. Liability gaps emerge. Regulatory violations create additional exposure.
Common Questions
If a sub has their own business but no insurance, are they still independent?
They might be independent, but you may be liable for their injuries. Always require insurance regardless of their business status.
What if someone works exclusively for me?
Exclusivity is a factor suggesting employee status. Multiple clients support independent contractor classification. This alone isn't determinative, but it matters.
Do I need certificates from every subcontractor?
Yes. Missing certificates can result in those workers being added to your payroll at audit.