Washington State Department Labor and Industries (sometimes referred to as L&I) routinely conducts financial audits and records audits of small businesses like general contractors, subcontractors and specialty contractors such as electricians, plumbers, sheet metal fabricators and installers, and roofing companies to assess workers' compensation premiums. L & I frequently uses the terms “industrial insurance” and “workers' compensation insurance” interchangeably and L & I also uses the terms “taxes” and “premiums” interchangeably during workers' compensation audits.
After a Labor and Industries audit, the auditor will issue a Notice and Order of Assessment of Workers' Compensation Taxes with the results of their audit.RCW 51.48.131A contractor or subcontractor will have thirty days to either (i) request a reconsideration with L & I or (ii) directly filing and appeal with the Board Of Industrial Insurance Appeals (sometimes referred to as the BIIA). Depending on the results of the audit and Notice and Order of Assessment, sometimes it is more strategic to request a Reconsideration, while other times Reconsideration should be bypassed and an appeal should be directly filed with the Board of Industrial Insurance Appeals. The formal term that Labor and Industries uses for Reconsideration is title “Order and Notice Reconsidering Notice and Order of Assessment.”
For contractors and subcontractors being audited for workers' compensation taxes, L & I audits and Reconsiderations typically center on four areas. The first area is whether a small business' subcontractors are considered independent contractors or “noncovered workers” who do not need to have L & I insurance or whether Labor and Industries will consider them employees or “covered workers.”
Construction trades should know that just because the IRS considers a business' subcontractors to be independent contractors that does not mean that the Labor & Industries will consider them to be. Many contractors and subcontractors are surprised to find out that the IRS has different rules for who is an independent contractor versus L & I and that a construction worker would be considered an “independent contractor” for IRS purposes, but for Labor and Industries purposes that same worker would be considered an “employee” or “covered worker.”
To make the determination of whether a construction subcontractor is an independent contractor or covered worker, Department of Labor & Industries will review bothRCW 51.08.180orRCW 51.08.181.
If a construction subcontractor meets the qualifications ofeitherRCW 51.08.180orRCW 51.08.181then your construction company will not need to pay industrial insurance premiums for them and they will be considered non-covered workers. The particular subcontractor does not need to satisfy bothRCW 51.08.180orRCW 51.08.181—they only need to satisfy either RCW 51.08.180 orRCW 51.08.181.
RCW 51.08.180and the most important case law on the matterWhite v. Department of Labor &Industries, 48 Wn.2d 470, 294 P.2d 650 (1956)state that if the primary purpose, or “essence,” of the “relationship” is the “personal labor” of the subcontractor then L & I premiums should be paid for them and they should be covered by workers' compensation insurance.
However, if the primary purpose, or “essence,” of the contract is not personal labor, then the business does not need to pay industrial insurance premiums and they are not “covered workers.”
In reality, what this means is Labor and Industries will look at what the subcontractor is doing and what equipment they are supplying to the job to complete the work. For example, if a plumber supplies all of their own very specialized equipment and expensive supplies, or an excavator brings their own front loader, then the business that hires them is hiring them more for their specialized equipment or motorized equipment rather than their actual labor.
However, if a carpenter or roofer simply supplies his own common hand tools, then the contractor is hiring them for their labor and they will not satisfy L & I that they comply withRCW 51.08.180.
If the subcontractor does not pass RCW 51.08.180, then the auditor will reviewRCW 51.08.181to see if they satisfyRCW 51.08.181before issuing a Notice and Order of Assessment of Workers' Compensation Taxes.RCW 51.08.181is a seven-part test that requires the L & I auditor to review seven different items for each subcontractor to see if they comply with all seven items. If the subcontractor satisfies all seven items ofRCW 51.08.181then the subcontractor will not need to be covered under workers' compensation insurance. If the subcontractor failsevenone of the seven items ofRCW 51.08.181then they will be considered a covered worker and industrial insurance premiums will have to be paid for them because they will be considered employees or covered workers. Contractors should note that the seven-part test ofRCW 51.08.181applies to the construction trades which includes, but is not limited to, electrical, plumbing, sheet metal, roofing, drywall, excavating, carpentry, HVAC and flooring. However, some subcontractors which are not related to construction, but assist in construction projects, that will only need to satisfy the six-part test ofRCW 51.08.195. For instance, transportation and loading like trucking or tow truck companies and most janitorial companies simply needs to satisfy the six-part test ofRCW 51.08.195and not the seven-part test ofRCW 51.08.181.
If some business subcontractors are considered employees and covered workers by Department of Labor & Industries, then second item an auditor will look at before issuing a Notice and Order of Assessment is to see what risk classification these employees and covered workers qualify under. It is very important to make sure that these workers are in the proper risk classification because the industrial insurance rates vary widely among the different construction trades. All the construction risk classes are found within the Washington Administrative Code atWAC 296-17A. For instance, plumbers are governed byWAC 296-17A-0306and their base rate in 2018 is $2.06 per hour worked, while sheet metal workers are governed byWAC 296-17A-0519and their base rate in 2018 is $3.21 per hour worked. Contractors can see the importance of proper classification when looking at just one example, which are the varying rates for carpenters and the carpentry companies. Building repair, remodeling and carpentry is governed atWAC 296-17A-0516and the base rate is $3.21 per hour worked in 2018, while interior finish carpentry is governed atWAC 296-17A-0513and the base rate is $2.11 per hour worked in 2018. This type of difference, and proper classification, can result in thousands of dollars of extra workers' compensation premiums, or workers' compensation tax savings, per worker.
Third, after determining the proper classification, the Labor and Industries' auditor will review the amount of hours to assess premiums upon before issuing the Notice and Order of Assessment. The auditor will look at the records of the employer to determine the amount of hours, per quarter, and per worker, and assess premiums on that amount. For instance, an HVAC contractor who works 400 hours in the first quarter of 2018 would be assessed $2.13 per hour for a total of $852 of worker's compensation premiums owed to the Department of Labor Industries.
Labor and Industries requires that contractors and subcontractors keep records for the purposes of paying workers' compensation insurance premiums.RCW 51.48.030states if contractors or subcontractors do not keep and preserve proper records then that employer will be barred from questioning any audit or Reconsideration before the Board of Industrial Insurance Appeals or in Superior Court. The records that must be maintained for each worker are set forth inWAC 296-17-35201.
If the contractor or subcontractor does not keep the records required by WAC 296-17-35201then the L & I auditor will use the Average Hourly Wage methodology to calculate the amount of industrial insurance premiums owed in the audit and the Notice and Order of Assessment. Essentially, what the auditor will do is review the total amount that the employer paid the worker each quarter, whether by Form W-2, Form 1099, or by reviewing the company's general ledger to determine payment over the quarter.
Once the total amount paid to the subcontractor or employee is calculated, the auditor will determine what type of construction trade that subcontractor or employee works in (e.g. asphalt paving, framing, brick mason or masonry, electrician, glass installation, plumbing, painting, HVAC etc.). The Department of Labor and industries sets a predetermined Average Hourly Rate that they believe each construction trade earns per hour. L & I will then divide the total payment by the Average Hourly Wage to estimate hours. Many times the Average Hourly Wage is less than the employer is actually paying the worker per hour. This can result in an unfair result where the auditor will determine that the worker workedmorehours, in a quarter, then they actually worked because the Average Hourly Wage is farlowerthan the actual wages or salary that the worker was paid.
After the auditor confirms the amount of hours worked per quarter and the total industrial insurance premiums due for that quarter, the L & I auditor will determine if any additional penalties should be assessed against the employer. If the contractor asserts that they only have independent contractors and no employees, but the auditor and Notice and Order of Assessment determine otherwise, the Department of Labor & Industries will assess an Unregistered Employer penalty against the employer.RCW 51.48.010,WAC 296-17-35204. If the contractor does not maintain proper records, then auditor will assess a penalty for Failure to Maintain Records.RCW 51.48.030,WAC 296-17-35201. If the contractor refuses to cooperate with the audit, the auditor may issue penalties for Failure to Cooperate.RCW 51.48.040
After going through this process, the Department of Labor and Industries will issue a Notice and Order of Assessment against the contractor or subcontractor. If a business does not agree with the determination made, it is critical that businesses be aware of the deadlines to ask for a Reconsideration or file an appeal with the Board of Industrial Insurance Appeals.RCW 51.48.131
Our firm can help will all stages, workers compensation/industrial insurance compliance, audit, Notice and Order of Assessment, Reconsideration, appeals before the Board of Industrial Insurance Appeals and appeals to the Superior Court.
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