Who qualifies for a workers' compensation exemption?

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Workers’ compensation insurance is required in most states for businesses that have employees. However, in some cases, business owners and workers can be exempt.
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America’s workers’ compensation system depends on nearly all employees having workers’ comp insurance. But certain types of employees, as well as some business owners, are workers’ comp exempt.

The benefits of workers’ compensation

In the early 20th century, state governments, employers, and employees made a grand bargain. Employers would automatically cover the costs of their employees’ work-related injuries and illnesses. In return, employees would give up their right to sue their employers when they got hurt or sick. The result? Employees would get immediate help with their doctors’ and rehab bills and receive a portion of their lost wages during their recovery. Meanwhile, their employers would avoid financially crippling lawsuits.

State governments would benefit, as well, since fewer workers with disabling injuries would end up on the public dole. However, to make this deal, employers had to agree to provide workers’ comp insurance to their workforce.

Fast-forward to today. Nearly every U.S. state and territory offers some form of workers’ comp protection. But even though most states require all employees to be covered, a few worker categories are exempt. Also, certain types of business owners – sole proprietors, independent contractors, and members of limited liability companies (LLCs) – can qualify for a workers’ compensation exemption.

Business owners and employees that qualify for workers’ comp exemptions

States often exempt firms that employ few workers. Or they may exempt employees who only work a nominal number of days a year or who earn relatively little. For example, agriculture workers or real estate agents are sometimes workers’ comp exempt due to the nature of their work.

Independent contractors, which companies hire to provide expertise or complete a project, are also usually exempt from coverage. Check with your state’s workers’ compensation laws to see which rules apply to your business.

Once you know which employee types are exempt, look for exemptions that relate to business owners. States often allow the following types of owners to opt out of their firm’s workers’ comp coverage:

  • Sole proprietors
  • Partners
  • Members of limited liability companies (LLCs)
  • Corporate officers who own more than a certain percentage of company stock

Do business owners without employees need to buy workers’ comp?

That’s a tricky question. The answer depends on both your ownership status and the customers or clients for whom you work.

If you’re a sole proprietor, partner, or LLC member in a firm with no employees, you (and all the other owners) can apply for the workers’ comp exemption that applies to your ownership status.

However, be prepared for customers to request a copy of your workers’ comp certificate of insurance before doing business. Why would a customer care about you having workers’ comp insurance? Because if you don’t have coverage and you get injured while working for them, they might be liable for your medical expenses. Similarly, if you hire independent contractors and they don’t have their own workers’ comp coverage – and you don’t either – your customer might wind up being liable for worker injuries. (Read more about this in our post: Do sole proprietors need workers’ compensation insurance?)

Protect your small business with workers' compensation insurance

Workers’ compensation and independent contractors

With the emergence of the U.S. freelance economy, many employers today hire independent contractors to complete most, if not all, of their work. The financial benefits of dealing with temporary or contingent workers is:

  • You don’t have to provide health insurance.
  • You don’t have to pay payroll taxes.
  • You don’t have to make contributions toward their 401(k) retirement plan.
  • You don’t have to include them in your workers’ compensation insurance policy (reducing your insurance premium).

With so many benefits, it’s understandable employers often prefer to work with contractors rather than hire employees. However, the IRS and other agencies are starting to look more closely at employee classification, and the penalties could be steep if contractors are misclassified. You could be held liable for workers’ compensation costs if a contractor is ruled by agencies as an employee.

Check with your state workers’ comp agency to determine their position on workers’ comp coverage for independent contractors.

How to qualify for a workers’ comp exemption

To qualify for a workers’ comp exemption, business owners typically need to complete a form with their state’s regulatory agency and pay a processing fee.

However, you must still buy insurance for all your employees who don’t qualify for an employee exemption. For example, assume you are the owner of a real estate agency, operating as a sole proprietor. You employ 40 commissioned real estate agents and eight office clerical employees. In most states, your workers’ compensation obligations would be as follows:

  • You can apply for a sole proprietor exemption for yourself.
  • Your commissioned agents would be exempt because they are independent contractors.
  • You’d have to buy workers’ comp insurance for your eight clerical employees.

A factor to consider: Just because you’re eligible for an owner’s workers’ compensation exemption, doesn’t mean you must apply for it. There are benefits to being covered by a workers’ comp policy, and you may decide to opt for coverage.

Similarly, you may have employees who are exempt under state statute, but whom you’re willing to insure regardless. Why? Because you might decide the cost of doing so is minimal and the upside of enhancing employee morale is significant. Plus, employees with workers’ comp coverage typically return to work sooner from a job-related injury or illness because they have immediate access to medical and rehab services.

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Examples of employee workers’ comp exemptions in different states

It’s important to understand that each state has its own workers’ compensation requirements. Even though there are broad similarities nationally, every state is unique in how it mandates coverage. Some examples of coverage exemptions in different states:

Maryland: Every business is required to carry workers’ compensation insurance coverage in Maryland. The exceptions to this requirement are agricultural employers that have fewer than three employees or an annual payroll that totals less than $15,000.

Delaware: Although the majority of Delaware employees must be covered by workers’ compensation insurance, some types of workers are exempt, including:

  • Low-earning agricultural and domestic workers
  • Some real estate sales professionals
  • People with government jobs
  • Independent contractors

Indiana: Some employees are exempt from Indiana workers’ compensation insurance and also are ineligible to elect optional coverage. These include:

  • Railroad employees covered under the Federal Employees Liability Act
  • Employees engaged in interstate or foreign commerce who have access to federal alternatives to state-based workers’ compensation (example: seamen, longshoremen, and riverboat casino employees)
  • Real estate employees (i.e., real estate agents who work as independent contractors for real estate brokers)
  • Independent contractors (based on a combination of IRS and state guidelines)
  • Independent contractors in the construction trades
  • Athletes on scholarship
  • Prison inmates
  • Volunteers
  • Coaches for youth sports teams

States also vary in terms of how they handle business owner exemptions, especially relating to corporate officers.

The cost of noncompliance

Given the importance of having workers’ compensation coverage, states don’t look kindly on employers who ignore their rules. Most states impose hefty fines for noncompliance and civil or criminal penalties. Many states also have the statutory power to shut your business down until you begin offering full workers’ comp protection to your employees. 

Unless you’re looking to pay a big fine – and potentially have your business closed indefinitely – it’s best to pay close attention to your state’s laws for workers’ comp insurance.

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