Workers' Comp Audit: What Texas Contractors Should Expect (and How to Prepare)

Your workers' compensation policy renews, and a few weeks later you get a letter: your insurer is scheduling an audit.

For contractors who are not prepared, this letter is the start of a stressful process that often ends with an unexpected bill. For contractors who know what to expect, it is a routine administrative step — and sometimes a source of a refund.

The difference is preparation.

Why Workers' Comp Policies Are Audited

Workers' compensation premiums are calculated based on estimated payroll at the start of the policy year. The insurer uses that estimate to set your premium. At the end of the year, they audit your actual payroll to see how close the estimate was.

If your actual payroll was higher than estimated, you owe additional premium. If it was lower, you get a refund or credit.

This is not a penalty or a sign that something went wrong. It is how workers' comp is designed to work. The audit is just the reconciliation step.

What Auditors Look At

A workers' comp auditor is trying to answer one question: what was your actual payroll during the policy period, broken down by job classification?

To answer that question, they will typically review:

Payroll records:

• Payroll journals or registers
• W-2s and 1099s
• Federal 941 quarterly tax returns
• State unemployment tax returns (TWC reports in Texas)

Subcontractor documentation:

• Certificates of insurance for every subcontractor you used
• Subcontractor invoices or contracts
• 1099s issued to subcontractors

Business records:

• General ledger
• Cash disbursement journals
• Check registers

The auditor is not looking for fraud. They are looking for accuracy. But inaccurate records — or missing subcontractor certificates — can result in significant additional premium charges.

The Subcontractor Certificate Problem

This is where most contractors get surprised.

If you hired subcontractors during the policy year and cannot produce a certificate of insurance showing they carried their own workers' comp coverage, the auditor will add their labor costs to your payroll — and charge you workers' comp premium on that amount.

The logic: if your sub did not have workers' comp and got hurt on your job, your policy could be on the hook. The insurer wants premium for that exposure.

For a roofing contractor who paid $200,000 to uninsured subs, this can mean a five-figure audit bill.

The fix is simple but requires discipline:

• Collect a certificate of insurance from every subcontractor before they start work
• Make sure the certificate shows workers' comp coverage (not just GL)
• Keep the certificates organized by policy year
• Follow up on expired certificates — if a sub's policy expired mid-project, you may have exposure for the period after expiration

Some contractors build this into their contract process: no certificate, no work. It is the cleanest way to protect yourself.

How Job Classifications Affect Your Premium

Workers' comp premium is not calculated on total payroll alone. It is calculated on payroll broken down by job classification — and different classifications have very different rates.

A roofing laborer (classification 5551 in Texas) carries a much higher rate than an office employee (classification 8810). If your payroll records do not clearly separate field labor from office and clerical work, the auditor may classify everything at the higher rate.

Common classification issues for contractors:

• Clerical and office staff should be classified separately from field workers — but only if they work exclusively in the office and have no field exposure
• Owners and officers can often be excluded from workers' comp in Texas — but this requires a specific election and documentation
• Multiple trade classifications — a contractor who does both framing and finish carpentry may have employees who work in both classifications; payroll should be allocated accordingly

Keeping time records that show which employees worked in which classifications — and for how long — gives you the documentation to support a favorable audit outcome.

Texas Is a Non-Subscriber State — But That Does Not Mean You Are Off the Hook

Texas is the only state that does not require most private employers to carry workers' compensation insurance. Employers can "opt out" of the state workers' comp system.

But opting out does not mean you have no liability. Non-subscribing employers in Texas:

• Cannot use the "exclusive remedy" defense if an employee sues for a work injury
• Are exposed to common-law negligence claims with no damage caps
• Must notify employees and the Texas Department of Insurance Division of Workers' Compensation of their non-subscriber status

For most contractors — especially those working on commercial projects or for GCs who require workers' comp certificates — carrying workers' comp is both a practical necessity and a significant liability protection.

If you are a subscriber (you carry workers' comp), your policy audit is the process described in this article. If you are a non-subscriber, you have different exposures and should talk to an agent about your options.

What to Do Before the Audit

30 days before:

• Pull your payroll records for the entire policy period
• Gather all subcontractor certificates of insurance
• Identify any subs for whom you do not have certificates and try to obtain them
• Separate payroll by job classification if you have not already

At the audit:

• Have all records organized and ready
• Be present or have someone knowledgeable available to answer questions
• Do not guess — if you are not sure about a classification, say so and offer to provide documentation
• Ask the auditor to explain any adjustments they are making

After the audit:

• Review the audit worksheet carefully before signing
• If you disagree with a classification or payroll allocation, ask for the basis and provide documentation to support your position
• You have the right to dispute an audit result — contact your agent if you believe the outcome is incorrect

How to Reduce Your Workers' Comp Premium Going Forward

1. Implement a return-to-work program Insurers give premium credits to employers who have a documented return-to-work program. Getting injured employees back to light-duty work faster reduces claim costs and your experience modification factor (EMR).

2. Maintain a strong safety program Your experience modification rate (EMR or "mod") is a multiplier applied to your base premium. An EMR below 1.0 means you pay less than the industry average. An EMR above 1.0 means you pay more. Fewer claims = lower mod = lower premium.

3. Keep subcontractor certificates current As described above, missing certificates are one of the most common sources of audit surprises. A simple tracking system prevents this.

4. Review your classifications annually Job classifications change as your business evolves. An annual review with your agent can catch misclassifications before the auditor does.

5. Consider pay-as-you-go workers' comp Pay-as-you-go programs calculate premium based on actual payroll each pay period rather than an annual estimate. This eliminates large audit bills and refunds — and improves cash flow.

Getting Help With Your Audit

If you receive an audit bill that seems too high, or if you are not sure how to prepare for an upcoming audit, call your agent before you respond to the insurer.

McKnight Insurance has helped Texas contractors navigate workers' comp audits for over 20 years. We can review your audit worksheet, identify potential errors, and help you dispute incorrect classifications or payroll allocations.

Call us at 817.277.6166 or get a quote online.

Key Takeaways

• Workers' comp audits reconcile your estimated payroll with actual payroll — you may owe more or get a refund
• Missing subcontractor certificates are the most common source of surprise audit bills
• Keep payroll records separated by job classification throughout the year
• Texas is a non-subscriber state, but most contractors need workers' comp for practical and liability reasons
• Your experience modification rate (EMR) directly affects your premium — fewer claims means a lower mod
• Contact your agent before responding to an audit bill you believe is incorrect