Avoid worker misclassification with proper workers’ comp class codes
Small business owners can avoid misclassification fines by assigning the correct workers’ compensation class codes to their 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 prepares objective 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 general contractor 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 contractor's code needs to accurately reflect the high-risk conditions he’ll face on the job.
It usually costs less to insure low-risk professionals like clerical workers than it does to insure general contractors, who are almost always considered high-risk. 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. According to the NCCI’s state directory, the following states use their own class codes:
- New Jersey
- New York
- North Carolina
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 insurance department.
When to reclassify an employee
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.
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.
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 other 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 and not 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.
Taking the steps to ensure that each worker is properly classified as either a contractor or employee, and that each is listed under the appropriate workers’ comp class code, can save employers money, as well as spare them from potential legal action.