Ask any small business owner about their annual workers’ compensation insurance audit and you’ll likely hear a sigh. The process is famously tedious and can be costly, primarily because many employers assume that their standard “gross payroll” is the amount insurance auditors use to calculate premiums.
In reality, insurance carriers calculate your premium based on a highly-specific legal metric called remuneration, money or substitutes for money given to an employee for their services.
While the National Council on Compensation Insurance (NCCI) sets standard guidelines for what counts as remuneration across most of the country, states love to write their own rulebooks. If you operate a multi-state business or employ remote workers, relying on a “one-size-fits-all” approach to your payroll records can lead to paying more premium than necessary.
Let’s break down the baseline ground rules—and the state-specific exceptions that could flip your next insurance audit on its head:
The Baseline Ground Rules: Inclusions vs. Exclusions
Nationwide, the baseline for what most insurance auditors look for is fairly standardized.
What’s IN (Subject to Premium)
- Base Wages & Salaries: Standard hourly pay and regular salaries
- The “Straight-Time” Portion of Overtime: If an employee’s regular rate is $20/hour and their overtime rate is $30/hour, the baseline $20 is always included.
- Involuntary “Tips” (Service Charges): Mandatory automatic gratuities added to large restaurant parties or catering bills count as employer revenue. When passed to employees, they are subject to premiums.
- Bonuses & Commissions: Performance bonuses, profit-sharing, incentive pay
- Time Off Paid by the Employer: Direct payouts for holidays, vacations and sick leave
Note: Deductions do not reduce the amount of wage that is subject to premium, even if they are deducted pretax. I have seen some confusion in this area because guidance may say “Section 125 deductions are included in the payroll used for workers’ compensation premium calculations.” This means that the pretax deductions are NOT subtracted. There are just a few state exceptions which are covered in the state-specific section below:
What’s OUT (Excluded from Premium)
- The “Premium” Portion of Overtime: Using that same $20 base/$30 overtime example, the extra $10 “premium” half of time and a half is entirely excluded. If you pay double time, then you can exclude half of the amount as half is the premium portion.
- Voluntary Tips: True tips left completely at the customer’s discretion
- Severance Pay: Dismissal or severance payouts
- Third-Party Sick Pay: Disability or sick leave handled by a third-party insurance carrier rather than paid directly from your company accounts
- Valid Business Expense Reimbursements: Group travel, tool allowances, mileage, etc. Just be sure you are not paying out a fixed amount for reimbursements, as that looks suspiciously as compensation and not reimbursement. Keep the receipts!
The State-Specific Traps Where the Rules Flip
If you have employees crossing state lines, the standard playbook goes out the window. Individual states feature massive variations that can cause a logistical nightmare if your payroll tracking isn’t mapped properly.
1. The Overtime Trap (Delaware, Nevada, Pennsylvania)
While most of the country allows you to deduct the “premium” portion of overtime and double time pay, Delaware, Nevada and Pennsylvania do not. In these states, employers must report 100% of gross overtime wages, making overtime hours significantly more expensive from a workers’ comp perspective.
2. The Tip Flips (Delaware, Pennsylvania, New Jersey)
While voluntary tips are normally excluded, Delaware and Pennsylvania require employers to include tips up to the baseline of the federal minimum wage. In New Jersey, gratuities are automatically included in your premium payroll calculations unless the specific NCCI classification code for your exact business type explicitly rules them out.
3. The California Perks Exception
California marches to its own beat. Unlike NCCI states, California excludes the value of lodging or meals given to employees (unless provided explicitly in lieu of cash wages). Furthermore, they exclude employee contributions to Section 125 Cafeteria plans, offering a bit of a premium break, compared to other states.
4. The Nevada Silver Lining ($36,000 Cap)
While Nevada doesn’t let you exclude overtime or tips, they offer a unique payroll cap. Once an individual employee hits $36,000 in gross earnings for the calendar year, you can completely stop reporting payroll for them on your workers’ comp reports. For high earners, this can save your business a fortune.
5. Texas Safety Rewards
Texas incentivizes workplace safety directly through payroll. If your business pays out “safety awards” in accordance with a formalized, written company safety plan, those specific bonuses are completely exempt from your premium calculations.
Hidden Savings: The Section 125 Loophole
While most states force you to calculate workers’ comp premiums on an employee’s gross pay before health insurance is deducted, a few independent states allow you to exclude Section 125 pre-tax deductions ( e.g. health, dental and vision premiums) from your workers’ comp payroll baseline. If your payroll system isn’t specifically mapped to subtract these deductions before generating your state insurance reports, you are leaving free money on the table.
- California (Governed by the WCIRB) – Explicitly excludes Section 125 salary reductions from remuneration
- Delaware (Governed by the DCRB) – Excludes Section 125 cafeteria plans
- Pennsylvania (Governed by the PCRB) – Excludes Section 125 cafeteria plans
- Michigan (Governed by the CAOM) – Excludes employee-paid pre-tax medical/cafeteria deductions
The Ultimate Audit Rule: The Burden of Proof is On You
Insurance auditors follow a very simple, rigid principle: If it isn’t explicitly itemized in your records, it defaults to being included.
If you provide reports that don’t clearly identify the different types of earnings and deductions, chances are the auditor will not seek out all of the exemptions and you will end up paying more premium. I have seen many cases where auditors don’t exclude exempt officers or exempt earning types, so it is always a good idea to know the rules and calculate your subject wages on your own, and make sure they match up with the auditor. If they don’t, you will want to file an audit dispute. There is nothing worse than paying an insurance premium you don’t have to pay. Lastly, if your payroll system can perform the heavy lifting of calculating and reporting on subject wages, let it do the heavy lifting. Save yourself some time and money!
While I make every attempt to ensure the accuracy and reliability of the information provided in this article, the information is provided “as-is” without warranty of any kind. PayMaster, Inc and Romeo Chicco do not accept any responsibility or liability for the accuracy, content, completeness, legality, or reliability of the information contained. Consult with your CPA, Attorney, HR Professional, or Workers’ Compensation Insurance Agent to ensure compliance. If PayMaster, Inc. handles reporting of your premium under a ‘pay as you go’ with your carrier, it remains your responsibility to properly classify employees, verify rates, and ensure the proper inclusion/exclusion of all remuneration paid to wards the premium calculation.
