Workers’ Compensation Insurance
What kind of work do you do?
Business owner in woodshop consulting clipboard.
Choose from the nation's best insurance providers
Logos of Insureon's business insurance carrier partners

How to avoid employee misclassification lawsuits and penalties

Misclassifying employees on a workers’ comp policy can result in fines and potential lapses with coverage. To avoid misclassification, make sure to assign the correct workers’ compensation class codes to your employees.

What are workers’ compensation class codes?

Workers' comp class codes are three- or four-digit codes that differentiate between the types of job duties performed by employees. The codes are created by the National Council on Compensation Insurance (NCCI), an organization that gathers data and that helps to establish workers' comp insurance rates. There are more than 700 NCCI codes. Each code:

  • Denotes the amount of risk and type of hazard each job or work environment may entail
  • Assigns a certain value based on these conditions
  • Helps insurance providers determine the cost of workers’ compensation insurance

Most employers have two or more NCCI class codes on their policy.

Using workers’ comp class codes to classify employees

An employer must include a classification code for each employee. When hiring new workers, it might be necessary to reclassify workers and assign them new codes.

For example, an interior designer who works primarily with residential clients has started receiving requests to work on commercial properties – meaning bigger projects. To keep up with the extra work, she decides to hire a junior designer and an administrative assistant as full-time employees. Her workers' compensation insurance policy must cover them both.

When adding the employees to her policy, the designer needs to make sure she is using the appropriate code to accurately reflect the risk and work environment faced by each employee. The assistant should be assigned a code that denotes she will be doing clerical work and faces less risk at work, while the designer's code needs to accurately reflect the risks she will face working at client job sites.

It usually costs less to insure low-risk professionals like clerical workers. The codes are a shorthand for denoting different levels of risk.

Do all states use NCCI class codes?

Most states use the NCCI classification system. However, there are some exceptions.

Additionally, some states create special classifications that may vary from the standard NCCI codes. The best way to ensure you're using the correct codes is to check with your state's Department of Insurance or consult with a licensed Insureon agent.

Get workers' comp quotes from top U.S. carriers

When to reclassify an employee’s workers’ comp class code

Your employees might need to be reclassified when they move to a new position or their job duties expand. Even a temporary shift in work duties may require a new or split code (usually used when employees perform dual roles). Sometimes small changes to an employee’s role can make a big difference when it comes to workers’ comp rates.

For example, if a clerical employee's role now includes leaving the office to make sales calls, the employee is exposed to new risks. Depending on how much time is spent away from the office, the employer may need to use a split code (one for clerical work and another for outside sales), and the workers’ comp rate may rise.

Misclassifying employees could cost employers more

Whether intentional or accidental, misclassifying one of your workers could lead to paying more in the long run.

Intentional misclassification

Though it may be tempting for employers to misclassify employees in order to reduce workers' comp premiums, it is likely that any misclassifications would be caught in an annual premium audit. The audit (sometimes called a payroll audit) is used to provide an accurate workers' comp premium for a policy period.

If a business owner is found to have made a classification error, he would be responsible for paying the outstanding amount owed once the premium has been recalculated. Some states carry severe penalties for misclassifying workers.

Accidental misclassification

Inadvertently misclassifying employees could mean that some employers are spending more on premiums than they need to. For example, if a business owner classifies all employees under the same code, he could be missing out on the chance to take advantage of lower risk codes for certain employees.

While the annual audit will likely catch the error, business owners can save some money upfront by taking the time to properly classify employees from the start.

Independent contractor or employee: Know the difference

Understanding when a worker is an independent contractor vs. an employee can sometimes be confusing. However, it’s important to understand the distinction for several reasons, including:

  • The IRS can audit a business for misclassifying employees as independent contractors. Employers found to have misclassified workers as independent contractors could end up owing back taxes, benefits, and overtime pay.

  • If a worker classified as an employee is really an independent contractor, the employer is spending unnecessary money. Employers pay part of an employee’s Social Security and Medicare taxes as well as workers' compensation coverage, if their state requires it. If the worker really should be classified as an independent contractor, the employer is spending money for no reason.

Differences between employees and independent contractors

Independent contractors usually have free rein over the manner in which they complete their work. That means they set their own schedules, except for deadlines. They usually provide their own tools and supplies for the work at hand, and they have the freedom to work for other clients.

On the other hand, employees typically only work for one employer, work at their employer’s place of business, need to work the hours set by their employer, and perform their work under the control and direction of their employer.

If you’re not sure how to classify workers, you can check with the IRS, consult your state’s guidelines, or seek guidance from a legal professional.

The high cost of misclassifying employees as independent contractors

Some employers try to save money on workers’ comp premiums by classifying workers as independent contractors when they are really employees. Not only is misclassifying employees illegal, but employers in certain states could also face a misdemeanor or felony charge (with possible jail time). Plus, they’ll have to pay serious fines and penalties.

For example, in Missouri, knowingly misclassifying employees as independent contractors means an employer could face penalties of $50 to $1,000 per day per misclassified worker and up to six months in jail per violation.

By ensuring that each worker is properly classified as either a contractor or an employee, and that each is listed under the appropriate workers’ comp class code, an employer can save money and avoid potential legal action.

Save money by comparing quotes with Insureon

Complete Insureon’s easy online application today to compare workers' compensation insurance quotes from top-rated U.S. companies. Once you find the right policy for your small business, you can begin coverage in less than 24 hours.

Updated: February 5, 2024
Compare workers' comp insurance quotes
Save money by comparing insurance quotes from multiple carriers.
Frequently asked questions about workers' compensationWhat to do when your employee is injured at workDo 1099 employees need workers' comp insurance?What are the penalties for not having workers' comp?Do you need workers’ comp if you have no employees?Best workers' compensation insurance for small businesses