Every Workers' Comp Policy Gets Audited
If you carry workers' compensation insurance, your carrier will audit your payroll at the end of each policy period. This isn't optional, and it isn't random. Every single policy gets audited.
The purpose is simple. Your premium at the start of the policy year was based on estimated payroll. The audit determines what your actual payroll was and adjusts your premium accordingly. If you hired more people than expected, you'll owe additional premium. If your payroll came in lower, you'll get a credit.
Contractors get surprised by audits more than any other industry because construction payroll fluctuates dramatically with project flow.
How the Audit Process Works
The Notice
About 30 to 60 days after your policy expires, you'll receive audit notification from your carrier. Some carriers send an auditor to your office. Others conduct phone audits or mail audit worksheets for you to complete.
Larger contractors with premiums over $25,000 almost always get physical audits. Smaller accounts may qualify for phone or mail audits.
What the Auditor Needs
Prepare these documents before the audit:
Quarterly payroll tax returns (Form 941 or state equivalents) for the entire policy period. Your general ledger showing all labor costs. Individual employee earnings records. 1099 forms for any independent contractors you used. Certificates of insurance from subcontractors. Your state tax filings. Overtime records separated from regular time.
The auditor will reconcile your actual payroll against the estimated payroll used to calculate your initial premium.
Classification Review
This is where it gets expensive or saves you money. Every employee must be assigned to a workers' comp classification code based on their actual job duties. A framing carpenter (code 5403) carries a much higher rate than an office manager (code 8810).
The auditor verifies that employees are classified correctly. If your bookkeeper has been coded as general construction labor, you've been overpaying. If your field superintendent has been coded as clerical, you've been underpaying and the audit will catch it.
Why Classification Matters So Much
California workers' comp rates vary dramatically by classification. Here's what the spread looks like:
| Classification | Code | Approximate Rate per $100 | |---------------|------|--------------------------| | Clerical Office | 8810 | $0.25 - $0.40 | | Plumbing | 5183 | $4.00 - $6.00 | | Electrical | 5190 | $3.50 - $5.50 | | Carpentry | 5403 | $8.00 - $12.00 | | Concrete | 5213 | $6.00 - $9.00 | | Roofing | 5551 | $18.00 - $28.00 | | Excavation | 6217 | $7.00 - $11.00 |
A $200,000 payroll classified as clerical generates roughly $600 in premium. That same $200,000 classified as roofing generates $40,000 or more. Proper classification isn't a minor detail.
The Subcontractor Trap
This catches contractors every year. If you hire subcontractors who don't carry their own workers' comp coverage, the auditor adds their payments to your payroll. Every dollar you paid that uninsured sub gets classified under the highest applicable rate and added to your premium.
A tile installer hired an uninsured helper for a summer, paying them $15,000 as a 1099 contractor. At audit, that $15,000 was added to the tile installer's payroll at the carpentry rate. Additional premium: roughly $1,500. The tile installer had no idea this was coming.
How to protect yourself: Collect certificates of insurance from every subcontractor before they start work. Keep copies on file organized by policy period. When the auditor asks for sub certificates, you need to produce them. No certificate means their payments become your payroll.
Overtime Rules
Here's a piece of good news most contractors don't know about. California allows you to exclude the premium portion of overtime pay from your workers' comp payroll calculation. If an employee earns $30/hour regular time and $45/hour overtime, you only report $30/hour for the overtime hours.
This can create meaningful savings for contractors running significant overtime. Make sure your payroll records clearly separate regular and overtime hours. Blended rates don't qualify for the exclusion.
Executive and Owner Payroll
In California, sole proprietors and partners can elect to be excluded from workers' comp coverage. If excluded, their payroll isn't included in the audit.
Corporate officers and LLC members who are actively involved in the business are automatically included unless they file an exclusion with their carrier. Their payroll is capped at specific amounts set annually by the state. Even if an owner draws $500,000 in salary, only the capped amount is used for premium calculation.
Dispute Resolution
If you disagree with audit results, you have options. Request a voluntary re-audit from your carrier. If the original auditor made errors, a second review often corrects them. Provide additional documentation that wasn't available during the initial audit. Some carriers will adjust classifications if you can demonstrate that employees' actual duties differ from how they were coded.
If you can't resolve the dispute with your carrier directly, California's Workers' Compensation Insurance Rating Bureau (WCIRB) provides a formal dispute resolution process.
Preparing for a Clean Audit
Throughout the policy year:
Keep payroll records organized by classification code. Collect certificates from every subcontractor at the time of hire. Track overtime separately from straight time. Report new hires and job changes to your insurance agent. Maintain clear records of owner and officer compensation.
Before the audit:
Reconcile your payroll records against quarterly tax filings. Organize subcontractor certificates by date range. Calculate your estimated audit payroll to anticipate whether you'll owe additional premium or receive a credit.
During the audit:
Be available to answer questions about employee duties and job assignments. Provide clear explanations for any payroll fluctuations. Have your CPA or bookkeeper available if the auditor needs clarification on your records.
When the Audit Results Arrive
You'll receive an audit statement showing your actual payroll by classification, the premium adjustment, and either an amount due or a credit. Additional premium is typically due within 30 days.
Large audit bills can strain cash flow. If the additional premium exceeds your budget, talk to your agent about payment arrangements. Some carriers offer installment plans for audit balances.
Common Questions
Can I avoid the audit?
No. Every workers' comp policy includes an audit provision. Refusing to cooperate with an audit can result in your carrier estimating your payroll at a much higher amount and canceling your policy.
What if my payroll was lower than estimated?
You'll receive a return premium credit, either as a refund check or applied to your renewal premium.
How far back can auditors look?
The audit covers only the policy period in question, typically 12 months. However, if prior audits were never completed, carriers can go back to audit those periods as well.
Do I need my CPA at the audit?
Not required, but helpful if your payroll is complex or your records need professional interpretation.