Workers comp audit defense checklist

The year-end workers comp audit is where small-business cash flow goes to die. The premium you paid through the policy year was an estimate. The audit determines what you actually owe. If actual payroll exceeded the estimate, or if any classification gets reclassified to a higher rate, the make-up bill arrives 90 days after the policy expires. Five-figure audit bills are common. Six-figure bills happen.

This page covers how to prepare before the audit arrives, what documentation matters, how the auditor evaluates classifications, and what to do when you disagree with the findings.

The audit timeline

The standard workers comp audit cycle:

Policy issued. Premium is calculated on estimated annual payroll, allocated by class code.
Policy period. You pay premium monthly or quarterly based on the estimate. Actual payroll may be higher or lower than estimated.
Policy expires. Audit notice arrives within 30 days. The carrier requests documentation.
Audit conducted. Auditor reviews documentation, may schedule a site visit or virtual call. Typical audit window: 90 days post-expiration [state-facts/CA.json, state-facts/NY.json, state-facts/TX.json].
Audit report issued. The report shows actual payroll by class code, any reclassifications, and the resulting premium adjustment.
Bill or refund. If actual premium exceeds paid premium, you owe the difference. If paid premium exceeded actual, you receive a refund (often applied as a credit to the next renewal).

The audit is not a negotiation. It is a calculation based on documentation. The opportunity to influence the outcome is in the documentation you provide.

What documentation matters

The auditor requests, and uses to evaluate:

1. Payroll records. Quarterly federal Form 941s, the annual W-3, and state quarterly wage filings (DE 9 in California, similar forms in other states). The auditor totals gross payroll by quarter and matches to your declared payroll.

2. 1099 records. All 1099-NEC and 1099-MISC forms issued during the policy period. The auditor reviews 1099 recipients and evaluates whether they should be classified as employees for workers comp.

3. General ledger or accounting records. When payroll records are insufficient, the GL is the next-best source. The auditor looks at wage and contractor expense accounts.

4. Subcontractor agreements and COIs. For every subcontractor paid during the period, the auditor wants the agreement and a COI showing workers comp coverage. Subs without current COIs get added to your policy.

5. Time records by class code. When employees work in multiple classifications, time records prove the allocation. Without time records, the governing-classification rule assigns all payroll to the highest-rated code touched.

6. Job descriptions. When employees' titles or job descriptions suggest higher-risk work than the assigned classification, auditors investigate.

7. Organizational chart. Helps the auditor understand who reports to whom and where employees fit operationally.

8. Operational documentation. Job-site photos, equipment lists, materials-purchase records. Help the auditor understand what the operations actually look like.

Pre-audit checklist

Before the audit notice arrives, prepare:

Quarterly:

Reconcile payroll records (941, state filings) against your accounting system. Catch discrepancies early.
Review every 1099 contractor for state classification-test compliance. Update agreements as needed.
Collect or update COIs from every active subcontractor. Note expiration dates and request renewals before the COI lapses.
Maintain time records that allocate hours by class code for any employee whose work crosses classifications.

At each policy renewal:

Review the prior year's audit report. Ensure the new policy's class codes and payroll estimates reflect the audit findings.
Update job descriptions for any role that has changed in scope or duties.
Re-confirm owner-exclusion elections (where allowed by state).

30 days before policy expiration:

Pull the past 12 months of payroll, 1099 records, and subcontractor records. Organize by quarter.
Confirm COIs are on file for every sub paid during the period.
Prepare a written summary of any operational changes during the period (new locations, new operations, new equipment).

The auditor's first analysis

When the auditor reviews documentation, they answer four questions:

1. Was the actual payroll equal to, more than, or less than the declared payroll? If actual exceeded declared, additional premium is due. If less, refund is due.

2. Were the assigned class codes correct? The auditor compares operational documentation against the bureau classification descriptions. If the documentation suggests a different classification, reclassification follows.

3. Were 1099 contractors properly classified? The auditor reviews 1099 recipients against the state's employee-classification test. Workers who fail the test are added to the policy as employees.

4. Were subcontractors insured? Every sub paid without a current COI gets added to the policy at the appropriate class-code rate.

Each of these analyses can produce additional premium, sometimes substantially.

Common audit findings and how to respond

Finding 1: payroll exceeded estimate. The cleanest finding. The carrier bills the rate difference times the excess payroll. There is generally nothing to dispute unless the payroll figure itself is wrong.

Finding 2: classification changed to higher-rated code. The auditor reviewed operational documentation and concluded a different code applies. Common examples: roofing reclassified out of carpentry, helpers reclassified from clerical to field, working owner reclassified from clerical-only to split allocation.

To dispute: provide written documentation supporting the original classification. Job descriptions, time records, photos of the actual work performed, and operational facts. If the documentation supports the original classification, request an underwriter review.

Finding 3: 1099 contractors added as employees. The auditor concluded the 1099 contractor is an employee under the state's classification test. Common in California (ABC test), Washington (strict criteria), and Massachusetts.

To dispute: provide evidence supporting the contractor's independent status. Multiple-customer evidence, separate business address, business license, contractor's own tools and equipment, independent business cards and marketing. If the documentation is strong, the underwriter or bureau may reverse the classification.

Finding 4: subcontractor labor added to policy. Subs without current COIs picked up at audit. The carrier adds the sub's payments to your policy at the appropriate class-code rate.

To dispute: produce a COI that was current during the work period. If the sub had coverage and you can document it after the fact, request that the auditor remove the addition. If no COI ever existed, the addition stands.

Finding 5: working-owner allocation changed. The auditor concluded the owner's actual operations include field work that was not allocated to the field code.

To dispute: time records showing the owner's actual hours by classification. Without time records, the auditor's reclassification stands.

The dispute process

When you disagree with audit findings, three escalation paths in order:

1. Underwriter review. Request a written review with documentation. The underwriter (not the auditor) reviews the findings and either confirms, modifies, or reverses. Most disputes resolve here.

2. Bureau reclassification petition (independent-bureau states). California (WCIRB), New York (NYCIRB), Pennsylvania (PCRB), and other independent-bureau states accept formal classification petitions from policyholders. The bureau reviews the petition, gathers evidence from both sides, and issues a written decision.

3. State DOI complaint. If the carrier refuses to engage and the bureau (where applicable) supports the carrier, file a complaint with the state DOI's market-conduct division. The DOI does not adjudicate classification disputes, but they compel the carrier to follow proper review procedures.

The dispute window is typically 60 to 90 days from the audit report date. Move quickly.

Pay-as-you-go (PAYG) as audit-shock prevention

The traditional audit model is the year-end-shock model. Pay-as-you-go is a structural alternative.

In PAYG, the carrier integrates with your payroll provider. Premium is calculated each pay period on actual payroll, by class code. There is no annual estimate-and-audit cycle, because every pay period is, in effect, a continuous audit. The premium you pay matches the premium you owe, in real time.

10 of the 14 carriers in our database offer PAYG [carriers/carriers.json]. The carrier list:

Travelers (PAYG: yes)
The Hartford (PAYG: yes)
Liberty Mutual (PAYG: yes)
Chubb (PAYG: yes)
AmTrust (PAYG: yes)
Zurich North America (PAYG: yes)
AmeriSure (PAYG: yes)
Employers Holdings (PAYG: yes)
ICW Group (PAYG: yes)
Pinnacol (CO state fund, PAYG: yes)

PAYG eliminates the year-end audit shock for the payroll-amount component. It does not eliminate the classification-correctness audit (auditors still review classifications), but the cash-flow impact is dramatically lower.

For employers who currently get hit with audit bills, switching to a PAYG carrier at the next renewal is the structural fix.

Common audit traps to avoid

Trap 1: bonus and overtime not allocated correctly. Bonuses are typically included in payroll for premium purposes. Overtime in some states is reduced to straight-time equivalents (CA, FL, others). Misallocation produces audit adjustments.

Trap 2: cash payments to workers. Auditors look for unexplained cash distributions in the GL that may indicate off-payroll workers. Document any cash payments and the underlying work to avoid reclassification.

Trap 3: excluded owners who actually drew payroll. If you elected owner exclusion but actually drew payroll during the period, the auditor may add the payroll back. The exclusion election removes the owner from premium calculation; it does not remove draws from your books.

Trap 4: subs paid through 1099-MISC instead of 1099-NEC. The 1099 form does not change the classification analysis, but auditors specifically pull 1099-NEC records for service-provider review. Misfiled forms can complicate the audit.

Trap 5: missing year-end documentation. Late W-3 filing or missing state quarterly filings make the auditor's job harder and may produce unfavorable adjustments. Keep documentation current.

Related resources

This is general information, not legal or insurance advice. Workers compensation audits have substantial financial consequences and limited time windows for dispute. Consult a licensed broker or attorney for your specific situation.

This is a syndicated post. Original article + interactive calculator: https://wcclasscode.com/articles/audit-defense-checklist/