Workers comp audit: what your books need

A workers comp audit usually arrives as a letter or email a few weeks after the policy renews: the insurer wants payroll records, tax filings and a list of subcontractors for the year that just ended. For a contractor, landscaper or cleaning company, the result is often a bill. Not because anyone did anything wrong, but because the premium was set on an estimate, and the books now show what really happened.

Insurers have written plenty about how the audit works. This post is about the other side: what the auditor asks for, where each record comes from in QuickBooks Online, and the bookkeeping habits that decide whether the final number is fair. The same records answer a general liability audit, which is covered near the end.

What is a workers’ comp audit?

Workers’ compensation premium is charged on payroll. When the policy is written, the insurer uses your estimate of payroll for each type of work, called a classification or class code, and multiplies it by that class’s rate. The audit replaces the estimate with the real figures.

That is written into the policy itself. The standard workers compensation policy form used in most states (NCCI form WC 00 00 00 C, Part Five) says the premium on the information page “is an estimate,” and that “the final premium will be determined after this policy ends by using the actual, not the estimated, premium basis.” If the final premium is more than you paid, you pay the balance. If it is less, the insurer refunds the difference.

The same form gives the insurer the right to look: “You will let us examine and audit all your records that relate to this policy,” including ledgers, journals, payroll and disbursement records and tax reports. Audits can happen “during the policy period and within three years after the policy period ends.”

Why is workers’ comp auditing me?

Because the policy ended. A premium audit is routine and is not an accusation. Insurers audit to true up estimated payroll, and AmTrust’s audit FAQ, for one, says “all Workers Compensation policies are subject to an audit.”

A premium audit is a different thing from a claims investigation or a fraud investigation:

	Premium audit	Claims investigation	Premium fraud investigation
Triggered by	The policy period ending	An injury claim	Signs that payroll or job duties were misreported on purpose
Looks at	Payroll, class codes, subcontractors	The injury, the worker, the medical file	Records over several years, often with the state’s fraud unit
Outcome	Additional premium or a refund	The claim is paid or disputed	Back premium, penalties, possible prosecution

If the letter is about payroll and subcontractors for a policy that just ended, it is the first column.

Do workers’ comp audits happen every year?

For most policies, yes: once after each policy period. The form of the audit varies. Smaller policies often get a mail, online or phone audit where you upload records. Larger ones get a physical audit, where an auditor visits or reviews the books with you on a call. The premium size that triggers a physical audit is set by state rules and carrier practice.

What happens in a workers’ comp audit?

1. The request arrives. Shortly after the policy expires, the insurer or an audit firm it hires sends a list of records and a deadline. Carriers vary on timing: Utica National says it aims to complete audits within 60 days of expiration, and AmTrust says most of its audits finish within a few months.
2. You send records for the policy period. Not the calendar year: the policy year, which might run April 1 to March 31.
3. The auditor rebuilds payroll by class code. Wages are sorted by what each employee actually did, and items that do not count as payroll are removed.
4. Subcontractors are checked. Every payment to a subcontractor is matched to a certificate of insurance. Payments without one may be added to your payroll.
5. Owners and officers are checked against the inclusions or exclusions on your policy.
6. The insurer issues a final premium. The audit statement shows the audited payroll by class and the additional or return premium.

The records the auditor asks for, and where they come from

Every item on a typical audit request comes out of your books or your payroll provider. The table assumes QuickBooks Online with QuickBooks Online Payroll; if you use Gusto, ADP or another provider, the payroll reports come from there.

The auditor asks for	Why	Where it comes from in QuickBooks Online
Payroll records for the policy period, by employee	The premium basis	Payroll Summary or Payroll Details report, dated to the policy period by check date
Payroll by class code, with overtime shown separately	Rating by class; the overtime premium is usually excluded	Workers’ Compensation report (QuickBooks Online Payroll Core, Premium and Elite)
Quarterly Form 941s and state unemployment reports	To verify that the payroll you report matches what you filed	Filed forms in your payroll tax archive, or from your provider
W-2s and W-3	Year-end verification	Payroll tax archive
1099s and payments to subcontractors	To find labor paid outside payroll	Expenses by Vendor Summary for the policy dates, plus the 1099s you filed
Certificates of insurance for each subcontractor	To exclude insured subcontractors	Attachments on each vendor’s profile, if you file them there
General ledger or cash disbursements	To find payments the payroll reports miss	General Ledger or Transaction Detail by Account report for the policy period
Profit and loss or tax return	A cross-check for labor paid outside payroll	Profit and Loss for the policy period; the filed return from your preparer
Job descriptions for each employee	To confirm class codes	Outside QuickBooks: a list of names, titles and duties

AmTrust explains why the profit and loss and tax return are on the list: the auditor uses them “to validate the existence of potential exposure from individuals/businesses you may have paid outside of your payroll.” A subcontractor coded to Repairs and Maintenance instead of a subcontractor or cost of labor account still shows up there.

Run every report for the policy period

The most common mismatch is dates. Policy periods rarely match the calendar year, and quarterly 941s never line up with an April-to-March policy, so the auditor uses the closest four quarters to check your payroll report. Run the payroll reports by check date for the exact policy dates, and expect the 941 total to differ by the payrolls at each end. If you can show that difference in a short worksheet, the auditor does not have to guess.

The Workers’ Compensation report in QuickBooks Online Payroll groups wages by the workers’ comp class entered on each employee’s profile (Team, then Employees, then Job & pay, then Employment details). It shows regular wages and “Premium wage paid,” which is the overtime premium. The report shows wages by the class on the profile, not hours by the work done, so an employee who splits time between two classes also needs time records by class; see splitting one employee’s payroll below.

What counts as payroll in a workers’ comp audit

Payroll for workers’ comp is not the same as payroll for income tax. Beacon Mutual, an NCCI member insurer, publishes the NCCI list of common inclusions and exclusions:

Included as payroll	Not included
Salaries and wages	Tips
Commissions	The extra pay for overtime (the difference between the regular rate and the overtime rate)
Bonuses	Severance pay
Holiday, vacation and sick pay	Third-party sick pay
Automatic gratuities and service fees	Tuition reimbursement
The straight-time portion of overtime
Salary reductions for employee savings plans or cafeteria plans (IRC §125)

States that run their own rating bureaus, such as California and Pennsylvania, publish their own rules, so check the list for the state the policy is written in.

The overtime exclusion only works if the books show it

The overtime exclusion is worth real money for trades that work long weeks, but it only applies when the payroll records show the extra pay separately, in dollars. If overtime is paid as one lump at time-and-a-half, or recorded as a bonus, the auditor cannot pull the premium portion out, and the whole amount is rated. QuickBooks Online Payroll records overtime as its own pay type, which is what fills the Premium wage paid column. Paying overtime through a regular hourly item, or as a flat bonus, loses it.

Owners and officers

Whether owners, partners, LLC members and corporate officers are covered, and whether their pay counts as audited payroll, depends on the state and on elections made when the policy was written. AmTrust’s FAQ says owners, officers, partners and members can elect to be covered or not “depending on the rules that vary by state,” and that this “must be done before the policy is issued.” Some states also set minimum and maximum payroll amounts for officers who are included. Check the policy’s information page and endorsements, and ask your agent before the renewal, not after the audit.

Uninsured subcontractors: the usual surprise bill

The policy form explains the most common surprise in one sentence. Premium is charged on the pay of your officers and employees, and also on “all other persons engaged in work that could make us liable” under the policy. That includes an uninsured subcontractor’s workers when state law makes the contractor responsible for their injuries. The form continues: “If you do not have payroll records for these persons, the contract price for their services and materials may be used as the premium basis.” That charge does not apply “if you give us proof that the employers of these persons lawfully secured their workers compensation obligations.”

The proof is a certificate of insurance (COI) showing the subcontractor’s own workers’ comp policy, covering the dates they worked for you. Without it, the whole amount you paid them can become your payroll.

A worked example

A landscaping company estimated $220,000 of payroll in one class when its policy was written. In this example the rate is $5.00 per $100 of payroll; real rates depend on the state, the class code and the carrier, before experience rating and other adjustments.

At audit, the books show:

Item	Amount
Gross payroll for the policy period	240,000.00
Of which, overtime premium (shown separately)	6,000.00
Subcontractor A, irrigation, COI on file for the whole period	26,000.00
Subcontractor B, tree work, no COI	12,000.00

The audited premium basis:

Line	Amount
Gross payroll	240,000.00
Less: overtime premium	(6,000.00)
Plus: Subcontractor B, uninsured	12,000.00
Audited payroll	246,000.00

Premium = Payroll ÷ 100 × Rate

	Payroll	Premium at $5.00 per $100
Estimate at policy start	220,000.00	11,000.00
Audited	246,000.00	12,300.00
Additional premium owed		1,300.00

Two bookkeeping details moved that bill. The missing certificate for Subcontractor B added $12,000.00 of payroll and $600.00 of premium. The overtime premium shown separately took $6,000.00 out and saved $300.00. Had overtime been paid as a lump sum, the bill would have been $1,600.00. Subcontractor A cost nothing, because its certificate was on file.

The size of the bill also comes from the estimate. If payroll is running well above the figure on the policy, ask your agent to raise the estimate mid-term, so the extra premium is spread over the remaining installments instead of arriving as one audit bill. Pay-as-you-go plans, which bill premium on each payroll’s actual wages, shrink the year-end difference further, though they still get audited.

How to stop it happening

• Collect a COI along with the Form W-9 before the first payment, and check that the dates cover the work. The 1099 post covers the W-9 side.
• Attach both to the vendor’s profile in QuickBooks Online (Expenses, then Vendors, then the vendor’s Vendor Details tab, then Attachments), so the audit request is a download, not a search.
• Diary the COI expiry date. A subcontractor whose policy lapses mid-year is uninsured for the months after it lapsed.
• Record every subcontractor payment to a subcontractor account, never to repairs or supplies, so the Expenses by Vendor Summary matches the COIs you hand over.

The contractor bookkeeping post covers the rest of the subcontractor controls, including 1099s and backup withholding.

Can one employee’s payroll be split between class codes?

Sometimes, and only with records. A landscaper who spends some weeks on lawn maintenance and some on hardscape construction may fall in two classes with different rates. California’s rules say an employee’s payroll can be divided only on recorded time, and without those records the payroll goes to the highest-rated class that applies to any part of the work. Other states have their own versions of the rule. Check yours with the carrier, and keep time by class (a timesheet or a time-tracking app) if the split matters to your premium.

What not to say during a workers’ comp audit

The safest audit is the one where the records do the talking. That means:

• Hand over what is asked for, for the policy period, from books that already tie. Payroll reports that match the 941s and a general ledger that matches the payroll reports leave little to question.
• Describe job duties accurately. Classification follows what people actually do, not their titles. An “office manager” who spends two days a week on job sites is not a clerical employee for rating purposes.
• Do not estimate figures on the spot. If a question needs a number you do not have, say you will pull it from the books and send it.
• Do not leave subcontractors off the list. The general ledger and the tax return are on the request precisely to find them.

What happens if you don’t complete a workers’ comp audit?

The insurer can bill you anyway. In 2015 NCCI filed an Audit Noncompliance Charge (Item B-1429) of up to two times the estimated annual premium for a policyholder who does not allow the audit. It applies only where the state adopted it and the Audit Noncompliance Charge endorsement was attached to the policy at the start of the term being audited. States decided separately: Texas rejected it, and North Carolina approved a modified version. The insurer can also cancel the policy or decline to renew it. If the deadline is too tight, ask for an extension in writing.

How to dispute a workers’ comp audit

Start with the auditor’s worksheet. Ask for the audit summary showing payroll by class, the subcontractors added and any items excluded, and compare it line by line with your records. Most disagreements are a missing certificate, an employee in the wrong class, or overtime not removed, and can be fixed by sending the missing record. If the insurer will not change it, the next step depends on the state. In states where NCCI administers the rules, NCCI’s dispute resolution process can review how the manual rules were applied, and the state insurance department hears appeals after that. Deadlines are short and vary by state, so act as soon as the bill arrives.

The general liability audit

A general liability policy is audited the same way, on a different premium basis. The standard commercial general liability form (ISO CG 00 01) says the “premium shown in this Coverage Part as advance premium is a deposit premium only,” and that the insurer computes the earned premium at the close of each audit period. It also says the first named insured “must keep records of the information we need for premium computation, and send us copies at such times as we may request.”

Which numbers matter depends on how each class is rated:

Premium basis	What the auditor wants	Where it comes from
Gross sales	Total charged for goods, work performed and rentals during the policy period	Profit and Loss for the policy dates
Payroll	Gross payroll by class	The same payroll reports as the workers’ comp audit
Subcontracted cost or total cost	Everything paid to subcontractors, including materials	Expenses by Vendor Summary, with certificates of insurance

Utica National’s audit guide, for example, defines subcontracted cost as the full amount paid to subcontractors for labor, material and equipment, including the value of materials you supplied for them to install. Gross sales are also asked for before deductions such as returns or discounts. If you collect sales tax, ask the auditor whether it should be backed out, and bring the sales tax liability report for the same dates. Uninsured subcontractors can raise the general liability premium too, so the same certificates do double duty.

When the books are not ready for the audit

An audit request is a deadline for the books. If payroll is in QuickBooks but subcontractor payments are coded to five different expense accounts, the COIs are in someone’s email, or the books stop months before the policy period ended, the audit becomes a reconstruction job.

Ledgerbrook brings books current through catch-up bookkeeping: every month of the policy period entered, reconciled and coded so subcontractors sit in one account and payroll ties to the 941s. The payroll reconciliation post covers the payroll side of that work. Trades with ongoing needs can start from the construction bookkeeping services, landscaping or cleaning business pages.

$99per month of backlog20% off 6+ months

After that, monthly bookkeeping at $149 a month keeps next year’s audit to a set of reports.

When to hand this off: if the audit deadline is weeks away and the books do not yet cover the whole policy period, or payroll does not tie to the 941s, start with the books before answering the auditor. A free file review tells you what is missing and what it costs to close the gap.