As a small business owner, your goal is to grow your business swiftly and sustainably. That means taking some risks, but also protecting yourself in the case of accidents or errors. You may already have general liability insurance and professional liability insurance to protect you when it comes to your dealings with clients. And depending on your state’s regulations, you may be required to take out a workers’ compensation insurance policy, too.
All 49 states (save for Texas) require small and mid-sized businesses to hold workers’ comp insurance. But these rules don’t always apply to small businesses.
So are you exempt? It depends on your state’s laws, your business model, and what kind of workers you employ. Even if you qualify for a workers’ comp exemption, it’s worth understanding just what these policies cover so you can evaluate whether one can contribute to your mission—healthy growth. This guide will explain all that and more. Let’s do this.
Workers’ compensation 101
Workers’ compensation insurance is designed to protect your business against liability in the event that an employee falls ill or is injured as a result of their work for you.
Thus, it protects both your employees and your small business. If an employee or independent contractor is injured, workers’ compensation can help cover their medical costs and lost wages while they recover. That way, your business can avoid large payouts for medical costs (or legal costs, should the case go to court) and continue operating normally.
Depending on the specifics of your policy, workers’ compensation can cover:
Accidents and injuries – Say you’re a kayak tour guide who hires a crew. Should one of them encounter raging waters on a trip and suffer an injury, you could be liable for their medical costs.
Illness – Say you’re a pet groomer who works with several employees. Should one of them catch an animal-borne illness, you could be liable for the cost of their treatment.
Repetitive stress injury – Say you’re a golf pro who works with an assistant. Should they develop elbow tendonitis from the repetitive swings, you could be held liable.
Disability – In situations like the above, an injury or illness could become chronic and prevent your employee from returning to work. In this case, you could be held liable for lost wages.
As you can see, workers’ compensation can protect businesses from costly payouts after accidents, especially when issues build up over time. Nonetheless, if you’re a small business owner, you may be looking to keep costs down.
In this case, it’s important to understand exemptions.
Common workers’ comp exemptions
Because there are no federal workers’ comp regulations, each state has unique laws regarding employers’ obligations. Even if your state requires most large and mid-sized businesses to carry this kind of insurance, it may contain an exception for small businesses like yours.
Below are some of the most common exemptions.
Excluded legal designation
When you formed your business, you chose a business type (LLC, S-Corp, etc). Depending on your business type and your state’s laws, you may be exempt from workers’ comp requirements. For example:
- In states including Connecticut and Ohio, members of a partnership don’t need to take out coverage.
- In Oklahoma, South Dakota, Utah, and other states, LLCs can apply for exemption.
- Sole proprietorships can choose to be excluded in several states.
A small number of employees
In many states, workers’ compensation laws exempt businesses with a low number of employees. Depending on your state, this exemption may apply to businesses with fewer than five members, or with fewer than two members. Check with the National Federation of Independent Businesses to understand your state’s laws.
Depending on your states, there may be exemptions for businesses hiring the following kinds of employees:
- Agricultural workers
- Church employees
- Household workers
- Members of a sports team
- Real estate agents and brokers
Total payroll costs
Several states exempt businesses whose payroll is below a certain minimum threshold, in which case workers’ compensation laws no longer apply.
Because these factors are highly variable based on your location, seek to understand your state’s requirements. If your business moves, don’t assume they’ve stayed the same. And in addition to these common exemptions, make sure you understand how your state’s laws apply not just to employees but also to independent contractors.
Workers’ comp and independent contractors
There’s one more common exemption we haven’t discussed yet. This one’s so important it needs its own section.
If you hire independent contractors rather than employees, you may assume you’re exempt from workers’ comp requirements. After all, they’re not technically an employee. However, it’s important to understand that just because you pay someone on a 1099 doesn’t mean your state views them as an independent contractor. Your state may take any of the following into account in defining employees vs. independent contractors:
- How you hired the worker
- How you pay them (hourly or salary vs. stipend or contract)
- When they are paid (weekly or monthly vs. at the end of a contract)
- How you report your payments (W2 or 1099)
- Who directs their work
- Who provides their tools and materials
Let’s take, for example, Washington’s laws. Say you’re a florist in Washington who pays an employee under-the-table to assist at your shop. Should that person be injured, they could sue you. Washington state would apply the three following criteria to determine whether they are an employee or an independent contractor:1
- Who directs them – If an independent contractor directs their own work or hires their own crew, they are not considered an employee. In a situation like the above, where the florist oversees their assistant, the assistant could potentially be considered an employee.
- If they bring their own tools – If an independent contractor brings their own specialized equipment, they are not considered an employee. If the florist assistant uses the shop’s shears and other tools, they could be considered an employee.
- If their business is different than yours – If an independent contractor has a legally registered business entity of their own, citing a different field or profession, they may not be an employee.
As you can see, in a situation like the above, the florist shop assistant is likely classified as an employee, and the shop owner could be held liable for medical costs. Beyond that, failure to provide workers’ compensation can lead to civil and criminal charges, as well as hefty fines.
As noted, state-by-state regulations vary. If you hire 1099 contractors, be sure to understand how your state classifies employees vs. contractors.
Doesn’t my existing insurance already cover employee injuries?
Unless you have workers’ compensation insurance, the short answer is no.
The long answer? Your general liability insurance provides coverage for client and third-party claims of bodily injury, personal injury, advertising injury, and property damage, while your professional liability insurance provides coverage against client and third-party claims of errors and mistakes related to your professional services.
Your employees and independent contractors are not clients or third parties. That’s why workers’ compensation insurance exists.
Protect your business
As you can see, even if you’re exempted from taking out workers’ compensation insurance by your state’s laws, it may still be a good idea. As a small business owner, you want to protect your business from all angles so that you can continue to grow with the right safeguards in place. To make sure a claim doesn’t damage your bottom line, consider the following policies:
- General liability and professional liability insurance to cover client and third-party claims
- Workers’ compensation to cover injuries to your employees and independent contractors
Your insurance has a monetary cost—but the cost of a claim could be much higher.
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Our editorial content is intended for informational purposes only and is not written by a licensed insurance agent. Terms and conditions for rate and coverage may vary by class of business and state.