Why Subcontractors Can Cost You Big in an Insurance Audit — And How to Avoid It

How Misclassifying Workers Can Cost Michigan Construction Businesses Thousands

If you’re a construction business owner in Michigan, chances are you’ve hired subcontractors to help with specific jobs. Maybe it's a roofer for a new build or a drywall crew for a renovation. Hiring subcontractors is often a smart move—it gives you flexibility, saves on payroll, and keeps overhead low.

But here’s the blunt truth: if you’re not handling subcontractor documentation correctly, your business is a ticking time bomb during insurance audit season.

The Audit Trap: Subcontractor Misclassification

Every year, insurance carriers conduct audits to verify payroll and classification accuracy. If they find that your "subcontractor" doesn’t meet the requirements for independent contractor status, guess what? You’re on the hook for their workers’ comp and general liability premiums.

And those retroactive charges? They aren’t small.

Let’s say you paid a subcontractor $80,000 for roofing work. If they didn’t carry valid insurance or proper documentation, your audit may reclassify them as an employee. Now you owe premiums on that full $80K—plus possible penalties.

Michigan’s Rules for Subcontractors

In Michigan, a true subcontractor must meet certain criteria. This includes:

• Having their own workers' compensation insurance policy

• Carrying their own general liability insurance

• Operating as an independent business (with their own tools, schedule, clients, etc.)

• Being issued a 1099, not a W-2

• Not being under your direct control or supervision

Fail just one of these requirements, and your insurance carrier might label them an employee.

The Most Expensive Mistake: No Proof of Insurance

The #1 issue we see in audits? No certificate of insurance (COI).

If you don’t collect and keep a COI from every subcontractor showing valid coverage at the time of work, the audit will assume the worst—and charge you accordingly.

Even worse, if the policy lapsed during the project and you didn’t catch it, you’re still responsible.

How to Protect Your Business

Here’s how you can bulletproof your audit results when it comes to subcontractors:

1. Require Certificates of Insurance — Always

Before any subcontractor sets foot on your job site, you should have a valid COI in hand showing:

• General liability insurance

• Workers’ compensation insurance (even if they’re a sole proprietor)
  Make sure the policy dates match the timeline of the project.

2. Keep Organized Documentation

Save COIs in a central location—digitally and backed up. Also keep contracts, invoices, and communication that show the subcontractor operated independently.

3. Use Contracts That Define the Relationship

Clearly spell out that the subcontractor is an independent business, not an employee. This can help during an audit or dispute.

4. Avoid Control and Supervision

You shouldn’t be dictating their work hours, methods, or providing tools. If you’re running their day-to-day, the line between contractor and employee blurs—and the audit hits harder.

5. Audit Your Own Subcontractors Regularly

Just like the insurance company audits you, you should review your subcontractor roster and documentation quarterly. Verify current insurance coverage and review contracts.

What If You Already Got Hit with a Subcontractor Audit Charge?

Don’t panic—yet. You may be able to dispute the audit findings if:

• You have COIs that weren’t submitted

• You can prove subcontractor status with contracts, invoices, or business credentials

Work with your insurance agent quickly. There are strict deadlines to file disputes or corrections. The faster you act, the better your odds of reducing the charges.

Bottom Line

In the construction world, subcontractors are a necessity. But mishandling them can turn into an expensive mess when the insurance audit comes around. Don’t wait for a premium hike to take action.

Start treating subcontractor documentation like safety gear—essential for protecting your business.

Sources:

• State of Michigan Workers’ Compensation Agency: www.michigan.gov/wca

• National Association of Insurance Commissioners (NAIC)

• Insurance Information Institute: www.iii.org

• Michigan Department of Licensing and Regulatory Affairs (LARA)

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