Uninsured Subcontractors: The Audit Bill You Did Not Budget

The policy year ends, an auditor asks for your books, and a few weeks later a bill arrives for more workers’ comp premium than your own crew can explain. One place that extra can come from is your subs: people you paid by the job, who had no workers’ comp of their own, and whose pay the insurer has now counted as yours.

It is a paperwork problem, and the paperwork has to be in the file before the first check, not found at the audit. This article explains why an insurer charges you for someone else’s crew, how an auditor turns a sub’s invoices into your payroll, and the short file to keep for every sub you pay.

Your premium is an estimate until the audit

The premium on your policy at the start of the year is a forecast. As the New York State Insurance Fund puts it, your billed premium is based on the payroll estimate you give at the beginning of the policy year, and because payroll changes over the year, a payroll verification (the workers’ comp audit) is needed to line the premium up with your actual payroll. Rates, class codes and who must carry the coverage are covered in workers’ comp: when your state requires it and what class codes do. This article is about one line of that audit.

On that line, NYSIF is blunt: if during your audit you cannot produce workers’ comp coverage documents for your subcontractors, your premium will be recalculated to include them in your payroll.

Why your insurer charges you for someone else’s crew

Because in some states the law makes you answer for that crew. Two examples:

• Florida. When a contractor sublets part of the work, all the employees of the contractor and the subs on that work are deemed employed in one business, and the contractor is liable for, and must secure, compensation for all of them, except the employees of a sub who has secured it (Fla. Stat. §440.10(1)(b)).
• North Carolina. A contractor who sublets work without first obtaining a certificate that the sub has coverage becomes liable to the sub’s employees. The certificate must be obtained before the contract is sublet (N.C. Gen. Stat. §97-19).

If your policy may have to pay a claim for a sub’s injured worker, your insurer wants premium for that exposure, and the audit is where it collects. Other states write the rule differently, so read your own state’s version before you lean on either of these.

How a sub’s invoices become your payroll

North Carolina’s Basic Manual, which the North Carolina Rate Bureau publishes online, spells out the arithmetic in Rule 2-H. It first asks for satisfactory evidence of the sub’s coverage, such as a certificate of insurance for the sub’s workers’ comp policy. Without it, the payroll counted for that sub depends on what records you have:

• The sub’s full payroll records: the auditor uses the payroll in those records.
• No complete payroll records, and nothing showing what part of the price was payroll: the full subcontracted price of the work done during the policy period counts as payroll.
• Documentation showing the payroll part of the price: the payroll it shows, but never less than a minimum share of the price.

Two more lines in the rule make the bill bigger than it looks. The sub’s payroll goes in the class that would have applied if those people had been your employees, so a roofing sub is charged at a roofing rate even if your own payroll is mostly carpentry. And your own experience modification applies to that premium too. Other states’ manuals have their own versions of this rule; your agent or carrier can tell you which one your policy follows.

California adds a licensing twist. In its guidance on audits for construction classifications, the State Compensation Insurance Fund says all subcontractors are required to have a valid contractor license, and that if you cannot show a sub’s certificate of insurance at the audit and the sub has no valid license, it may treat the sub as your employee for workers’ comp purposes and charge the premium. It also says payments to uninsured or unlicensed workers that you report on Form 1099 may be subject to premium and included in the audit as payroll.

A worked example

Say a remodeler in North Carolina paid an uninsured drywall sub $30,000 during the policy year, half of it for material, and has no certificate. The rate below is illustrative, not a real one: rates depend on the state and the class code.

The middle line is as low as the split can take it: under the table above, a labor-and-material sub never counts for less than half the price. Before the experience modification, the gap between the first line and the last is $2,700 of premium on one sub, for want of one sheet of paper. Multiply that by every uninsured sub you used in the year.

A 2020 audit post from Builders Mutual describes the same split from the insurer’s side. For workers’ comp, it says the auditor can remove material costs up to 50 percent of the total paid to an uninsured sub if you have original invoices breaking out material and labor; for general liability, which is audited too, it says the actual cost of material, up to 50 percent, is removed on the same condition. Invoices that split the two help on both policies.

The file to collect before the first payment

1. A certificate of workers’ comp insurance. NYSIF notes that a certificate shows active coverage as of the date of the certificate, and recommends getting one before work starts and once a year after that. Check that the policy dates cover every day the sub works for you.
2. A check that the coverage is real. Some states let you look coverage up online. The Texas Department of Insurance, for one, points to an online lookup for employers insured through private carriers, and NYSIF’s subcontractor page points to a certificate validation tool.
3. A Form W-9. The IRS requester instructions say the W-9 is used to request a U.S. person’s taxpayer identification number. If a payee fails to furnish one, the payer must withhold 24 percent of reportable payments and deposit it with the IRS until the cause is fixed, and a payer who does not collect it may become liable for the uncollected amount. Get the form before you pay, not in January.
4. Original invoices that split labor from materials. As the example shows, that split can take half of a labor-and-material sub’s price out of the count.
5. The sub’s license, where your state requires one. In California, State Fund’s position on unlicensed subs makes this part of the audit file.

State Fund asks for a certificate from every sub who has employees of their own. What a carrier accepts for a one-person sub with no employees differs by carrier and state, so ask yours before the job, in writing, not at the audit. If the person is really working under your direction, the question may be a different one: 1099 or W-2? walks through the tests.

At year end: the 1099-NEC

The IRS instructions for Forms 1099-MISC and 1099-NEC say you generally report a payment as nonemployee compensation when four things are true: the payee is not your employee, the payment was for services in the course of your trade or business, it went to an individual, partnership, estate or, in some cases, a corporation, and you paid that payee at least $2,000 in the year. The IRS FAQ gives the history: $600 for earlier payments, $2,000 for payments made after December 31, 2025, and the instructions say the figure may be adjusted for inflation beginning in 2027.

• Materials can count. Payment for services includes parts or materials used to perform them, if supplying the materials was incidental to the service.
• Corporations generally are not. Payments to a corporation, including an LLC treated as a C or S corporation, are generally not reported, with exceptions such as attorneys’ fees.
• One deadline. You must furnish the payee’s copy and file with the IRS by January 31.
• Backup withholding changes the rule. If you withheld any federal income tax under backup withholding, you file a 1099-NEC for that payee whatever the amount.
• Ten returns means e-file. Since tax year 2023, 10 or more information returns in total must be filed electronically; the IRS’s IRIS portal is free.

Your 1099 list is also a list an auditor can use: State Fund, as noted above, says payments to uninsured or unlicensed workers that you report on Form 1099 may be included in the audit as payroll. Every name on it is a sub who should have a certificate in the file for the dates you paid them.

If the bill has already arrived

Ask the auditor, in writing, which documents would change the count: a certificate covering the dates the sub worked, the sub’s own payroll records, or invoices that split labor from materials. Then send what you can find. And start the file for next year’s subs this week, before the next first check goes out.

General information, not legal or tax advice. Rules change and vary by state; check with the agency named above or a professional for your situation.