Payroll Audits
What is a payroll audit and why is it important?
The premium base for workers' compensation insurance is your business' payroll (also called remuneration). When a policy is written, the policy defines the premium as a certain rate per $100 of payroll for the policy period. Following the conclusion of the policy period, an audit is conducted to determine the actual payroll (premium base) to compute the final earned premium. If the final earned premium is more than the initial premium you paid, you must pay the additional balance. If it is less, you will receive a refund for the overpayment or a credit to any balance owed.
Calculating Remuneration
The NCCI Basic Manual provides explicit rules regarding the forms of remuneration that should be included in determining the total. Premium is computed on the basis of total remuneration paid or payable by the insured for services of individuals who could receive workers’ compensation benefits for work-related injuries as provided for by the policy.
Remuneration refers to money or substitutes for money. In addition to ordinary wages or salaries, several other types of compensation are included when calculating remuneration:
- Commissions
- Bonuses
- Overtime wages (1/3 of gross overtime wages are excludable)
- Pay for holidays, vacations or periods of sickness
- Payment to employees on any basis other than time worked
- Payment or allowance for hand tools
- Value of apartment or housing
- Value of lodging, other than apartment or house
- Value of meals
- Substitutes for money
- Payment for salary reduction, retirement and cafeteria plans
- Davis-Bacon wages paid to employees or placed by an employer into third-party pension trusts
- Annuity plans
- Expense reimbursement to the extent that records do not substantiate the expense as having been incurred as a valid business expense
The following items are excluded from the total remuneration:
- Tips and other gratuities
- Payments by an employer to group insurance or pension plans
- Special rewards for invention or discovery
- Dismissal or severance pay
- Payments for active military duty
- Expense reimbursements to the extent that records substantiate the expense as having been incurred as a valid business expense
- Supper money for late work
- Work uniform allowance
- Employer-provided perquisites
Owners and Executive Officers
The NCCI Basic Manual specifies minimum amounts that should be included for executive officers and for partners or sole proprietors. Remuneration only for executive officers or owners that are covered by the policy should be included as part of the premium base. They can elect to be excluded from coverage; however, the policy must be endorsed with the Exclusion Endorsement.
Subcontractors
Policyholders must either furnish satisfactory evidence that the subcontractor has insured the exposure or pay premium based on the subcontractor’s payroll. A certificate of insurance issued by the subcontractor’s insurer can demonstrate that insurance covers the subcontractor’s statutory workers’ compensation obligation. A certificate of insurance should always indicate coverage for the state and preferably the location (or locations) at which the subcontractor performs work, and for the period for which coverage is in effect.
If the subcontractor’s payroll records are not available, the full subcontract price for the work performed during the policy period will be included in the premium basis. If investigation reveals that a definite amount of the subcontract price represents payroll, that amount is included as payroll for the additional premium computation. However, that amount must be at least 50 percent of the subcontract price in contracts for labor and materials and at least 90 percent of the subcontract price in contracts for labor only. If the contract is for mobile equipment with operators, the amount included must be at least 33 1/3 percent of the subcontract price.
How to Prepare for the Payroll Audit
After the end of the policy period, expect a call or correspondence from an auditor. The auditor needs several things:
- Description of operations
- Executive officers – titles, duties and ownership percentage
- Detailed job duties for each employee
- Contract labor, subcontract labor and type of work performed
The auditor will request copies of certain records including:
- Payroll records – cash receipts and disbursements journals, check registers, petty cashbook, payroll journal, individual earnings records, general ledger, federal and state income tax returns, employer’s quarterly federal tax returns (Form 941), employer’s quarterly state unemployment returns (SUTA), 1099 and 1096, financial statements and miscellaneous records
- Gross dollar amounts of overtime paid totaled and separated by employee
- Subcontractor invoices and certificates of insurance
