Workers'' Comp for Contractors: Class Codes, Ghost Policies, Audits

A remodeler I’ll describe as typical bought a workers’ comp policy in January, paid a $4,100 deposit premium, and forgot about it. In March of the following year the auditor’s invoice arrived: $17,000 due in 30 days.

Nobody got hurt. There was no claim. The business just did work that didn’t match the class code on the policy, paid more payroll than it estimated, and hired one sub who couldn’t produce a certificate of insurance.

Workers’ comp is the one insurance line where the price you’re quoted is not the price you pay. It’s a deposit. The real number gets calculated after the fact, from your books, by someone whose job is to find payroll you didn’t report. Here’s how the math works and where it bites.

How the premium is actually calculated

Every workers’ comp policy runs on the same formula:

(Payroll ÷ 100) × class rate × experience mod = manual premium

Then add fees — an expense constant, terrorism surcharge, state assessments. Those are small. The three variables above are everything.

• Payroll is gross wages, including the owner if the owner is covered. At the start of the year you estimate it. At the end, the auditor pulls the real number.
• Class rate is a dollar amount per $100 of payroll, set by class code. Clerical work might be under $0.50. Roofing in some states runs north of $25. This is the biggest lever in the whole formula.
• Experience mod starts at 1.00 for everyone. After roughly three years of policy history — and only if your premium is large enough to qualify — it adjusts up or down based on your claims. A new shop is always 1.00.

Notice what’s missing: how careful you are, how good your safety record is, whether you’ve ever had a claim. In year one, none of that touches the price. Your premium is almost entirely a function of what code your work gets assigned to.

Class codes: the number that moves the most money

Most states use NCCI class codes (a handful run their own systems — California, New York, Pennsylvania, and a few others). Codes are specific. There are separate codes for interior carpentry, residential framing, commercial framing, roofing, siding, drywall, and so on. The rates between them are not close.

Illustrative spread for a residential remodeler — your state’s numbers will differ, sometimes by a factor of three:

Work	Example rate per $100 payroll
Clerical / office	$0.35
Carpentry — interior trim, cabinet install	$6.80
Carpentry — residential framing	$14.00
Roofing	$26.00

On $60,000 of payroll, that’s $4,080 at the trim rate and $15,600 at the roofing rate for the exact same dollars of wages.

How the misassignment happens

It is almost never fraud. It goes like this:

1. You apply for coverage. The agent asks what you do. You say “remodeling, mostly kitchens and baths.” You get coded as interior carpentry.
2. Eight months in, a good customer asks you to tear off and re-roof the back of the house. Then a referral wants a deck and a dormer. You say yes, because saying yes to good customers is how the business grows.
3. You never call your agent, because nothing changed from your point of view. You’re still you, still doing remodeling.
4. At audit, the auditor reads your invoices and your job descriptions. Roofing labor gets reclassified to roofing. Retroactively. For the whole year.

The auditor doesn’t need your permission. Classification is based on the work performed, not the box you checked in January.

There’s also a governing class rule to know about. In most states you can split payroll across multiple codes only if your payroll records show, by employee, the hours spent in each classification. If your records don’t split it out, the auditor can assign all of an employee’s payroll to the highest-rated code that employee worked in. One day on a roof can reclassify a whole year of that guy’s wages.

The worked example

Back to the $17,000. Here’s what the auditor found.

What was quoted in January:

Item	Amount
Estimated payroll (1 employee, owner excluded)	$60,000
Class code	Interior carpentry @ $6.80
Deposit premium	$4,100

What the audit actually assessed:

Payroll found	Code assigned	Rate	Premium
$26,000 interior trim	Carpentry	$6.80	$1,768
$56,000 roofing & exterior	Roofing	$26.00	$14,560
$18,000 paid to one uninsured sub	Roofing	$26.00	$4,680
Total earned premium			$21,008
Less deposit already paid			($4,100)
Balance due			$16,908

Three mistakes stacked. Payroll came in $22,000 over the estimate. The majority of it was roofing, not trim. And one sub had no coverage of his own.

Any one of those alone would have been survivable. Together they produced a bill bigger than most small shops’ annual profit.

Uninsured subs get charged back to you

This is the part that blindsides people who think “1099 means not my problem.”

For workers’ comp purposes, in most states, a subcontractor who can’t prove his own coverage is treated as your employee. Doesn’t matter that he has an EIN, carries his own tools, sets his own hours, and signed an independent contractor agreement. The agreement is an IRS-and-labor-law document. The auditor is running a different test: did this person have workers’ comp coverage in force on the dates he worked for you?

If the answer is no, his pay becomes your payroll at your class rate.

Three traps inside this:

1. The certificate has to cover the dates. A certificate of insurance dated last March doesn’t prove coverage for work done in November. Collect a fresh cert at the start of each job, and a renewal cert if the sub’s policy lapses mid-job.

2. The sub’s owner may be excluded on his own policy. This is the one almost everyone misses. A one-man sub can carry a policy that excludes himself as an officer or sole proprietor. The certificate looks real. But there’s no coverage on the only person who actually swung a hammer on your job, and in many states the auditor will charge that payroll back to you anyway. Ask directly: is the owner included or excluded? Get it in writing.

3. Materials don’t get separated unless the invoice separates them. If a sub bills you $20,000 with no labor/material breakdown, the auditor can charge the full $20,000 as payroll. Require every sub invoice to split labor and materials on separate lines. On a $20,000 invoice that’s actually $8,000 labor, at a $26 rate, that one formatting habit is worth $3,120.

If you’re weighing crew models, the comp charge-back is a real cost line that belongs in the comparison — see first employee vs. subcontractors.

What a ghost policy does and doesn’t do

A ghost policy — sometimes called a minimum-premium or if-any policy — is a workers’ comp policy with no covered payroll on it. You’re a one-man shop, you’ve excluded yourself, and you have zero employees. The policy exists so that a certificate of insurance exists.

What it does:

• Satisfies a general contractor or property manager who won’t let you on site without a cert.
• Satisfies state license board or city permit requirements that demand proof of comp.
• Keeps you from being charged back to the GC’s policy, which is often what the GC actually cares about.
• Costs a minimum premium — commonly in the several-hundred to low-four-figure range per year, depending on state and class code.

What it does not do:

• It does not cover you. If you fall off a ladder, there is no indemnity benefit, no wage replacement, no medical coverage under that policy. And your personal health plan may deny the claim because the injury was work-related. That gap is the single biggest risk a one-man shop carries.
• It does not cover your subs. See above.
• It does not let you hire quietly. If you put someone on payroll mid-year, the policy will respond to a claim — but the audit will find the wages and bill you for them at full rate.

Whether you can even exclude yourself depends on your entity and your state. Sole proprietors and partners are typically excluded by default and can elect in. Corporate officers and LLC members usually can elect out. If you elect to cover yourself, most states assign you a statutory payroll figure rather than using your actual draw — so your premium is based on a number the state picked. Ask your agent what that figure is before you decide. This sits alongside your GL and auto decisions; the full picture is in contractor insurance 101.

Surviving the year-end audit

The audit is a document review, not an inspection. Make it boring.

1. Keep payroll split by class code, by employee, by pay period. Not a memory exercise in March. If your payroll software supports multiple work classifications, turn it on in January.
2. Separate overtime correctly. Most states let you exclude the premium portion of overtime — the extra half of time-and-a-half — but only if your records show it separately. If OT is buried in gross wages, you pay comp on all of it.
3. Build a sub file. One folder per sub: signed agreement, current certificate, policy dates, owner-included-or-excluded confirmation. Pull a fresh cert every renewal.
4. Require split labor/material invoicing from every sub, in your subcontractor agreement.
5. Call your agent when your work mix changes. Adding roofing, excavation, or anything above 10 feet is a phone call, not a surprise. Mid-year class changes are far cheaper than retroactive ones.
6. Reconcile your own estimate mid-year. At month six, compare actual payroll to the estimate. If you’re tracking 40% over, tell the carrier and adjust the deposit. Paying in installments beats a lump sum you didn’t plan for.
7. Ask about pay-as-you-go. Many carriers will bill premium off each payroll run instead of an annual deposit. It smooths cash flow and shrinks the audit surprise to near zero.

And price the real rate into your jobs. If your comp rate is $26 per $100 of payroll, that’s 26% on top of wages for that work — a load most contractors never put in their hourly math. The overhead and hourly rate calculation only works if the comp number in it is the one your auditor will use.

State rules you have to go check

This varies more than almost anything else in your business:

• Monopolistic states — North Dakota, Ohio, Washington, Wyoming — require you to buy from the state fund. Private carriers can’t write it. Washington bills by employee hours worked, not payroll dollars.
• Texas makes comp optional for most private employers, but non-subscribers give up key legal defenses in an injury lawsuit. Optional is not the same as free of risk.
• Employee thresholds differ. Some states require coverage at one employee, others at three, some at five. Construction is frequently carved out and held to a stricter threshold than other industries.
• Owner exclusion rules differ by entity type and state, and some states cap how many officers can be excluded.

Don’t take any of this from an article. Pull up your state’s workers’ comp division site and your state rating bureau, and confirm the threshold, the exclusion rules, and your actual class rates.

Your next move

Pull out your current workers’ comp declarations page and find the class code listed on it. Then look at the last ten jobs you invoiced. If more than a small slice of that work doesn’t match the code on the dec page, call your agent this week and get the classification corrected going forward.

A mid-year class change costs you a higher premium starting now. A reclassification at audit costs you a higher premium going back twelve months, all at once, in one invoice.