The Importance of Verifying Independent Contractor Status

Throughout the construction industry, it is common for organizations to hire independent contractors (IC) to perform various tasks. Done correctly, there is tremendous value to the contracting organization – they don’t have to withhold income tax, Social Security or Medicare payments, and they aren’t responsible for benefits, such as health insurance, workers’ compensation insurance, or paid leave. However, if an organization doesn’t properly document and verify the status of their independent contractor, they can be in for a very expensive surprise when their workers’ compensation carrier performs it an annual premium audit.

An independent contractor includes, but is not limited to, one who maintains a separate business, holds him or herself out to and renders service to the public, and does not rely on one source of work income. Independent contractors may operate as a sole proprietor, partnership, corporation, or limited liability company.

In July 2022, the Michigan Workers’ Compensation Placement Facility published guidelines to clarify the process for establishing whether an individual can be considered an independent contractor or whether they must be reported as an employee. The issued statement acknowledges, “Whether you’re an insured policyholder or an insurance agent, Michigan workers’ compensation requirements for insureds that use contractors have long been a topic of discussion, dispute and confusion.”

Independent Contractor Status

If an organization intends to hire an independent contractor to perform services on a project, it must collect adequate evidence to support the IC status. There are several pieces of information to collect, including but not limited to:

• Registration as a DBA with the State of Michigan;
• A Certificate of Insurance for Commercial General Liability Insurance;
• Documented work performed for other organizations;
• Advertising in the general marketplace to solicit business;
• Invoices issued for services provided.

In addition, an IC that operates as a sole proprietor, i.e. has no employees, must also complete an Independent Contractor Worksheet. Payment to a contractor, evidenced by IRS Form 1099, does not prove someone is an independent contractor.

Workers’ Compensation Insurance

A sole proprietor without employees is deemed by the State of Michigan to be ineligible for workers’ compensation coverage under the WC Act, however, the hiring organization must ensure the contracted work can be feasibly completed by one person within the project timeline.

All other independent contractors, including sole proprietors who hire employees, must obtain a valid workers’ compensation policy or obtain an authorized exclusion.

Workers Compensation carriers are required to perform annual premium audits for their policyholders and verifying the status of any 1099 contractor is a top priority. If the hiring organization hasn’t collected the required evidence to confirm the IC status, the comp carrier will likely assess the organization for additional workers compensation policy premiums to cover the work performed by the IC.

Case Studies

Sole Proprietor

John Smith, a carpenter operating as SmithIt Construction LLC, has performed approximately $75,000 in projects completed for XYZ Inc., a general contractor. XYZ is audited by their workers’ compensation carrier. The audit requests additional information from SmithIt Construction to verify their Independent Contractor/Sole Proprietor status. SmithIt produces a link to their Facebook page (documenting their “advertising to the general public”), a certificate of liability insurance, and several invoices for work completed on XYZ projects. The comp carrier reviews the invoices and determines that the type of work performed – new roof, windows, and siding for several different homeowners - would have required more than one person to complete the job. The comp carrier provides an audit raising annual premium by $22,000, noting a “contractor is responsible for the payment of compensation benefits to employees of uninsured subcontractors.”

Independent Contractor

Mike Brady, a post-construction clean up laborer operating as MAB LLC, has performed approximately $63,000 in completed work for XYZ Inc., a general contractor. XYZ is audited by their workers’ compensation carrier. The carrier requests additional information to verify the Independent Contractor/Sole Proprietor status. Mike Brady produces his invoices for work performed for XYZ; however, he has no documentation to suggest that he has worked for any other organization. The carrier determines that Mike should be considered an employee of the organization and raises the annual premium by $6,300 for the year.

Penalties

In the guidelines issued by Michigan Workers’ Compensation Placement Facility, consequences of failing to verify IC status could result in additional payroll on a workers’ compensation policy, which would result in a significant increase in premium cost. In addition, Michigan law holds businesses responsible for providing workers’ compensation benefits to employees or laborers of any uninsured contractors it hires, or uninsured subcontractors its contractor(s) hires, to assist in providing its products or services.

Similarly, an insurance agent’s failure to advise its client on these requirements and responsibilities could lead to Errors and Omissions liability for not providing adequate professional services advice as a licensed Michigan insurance agent.

For further information, please contact your insurance agent or insurance carrier.