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If you need anything, please do not hesitate to contact us. In addition, a large portion of the state’s budget is made up of money collected as state payroll taxes. It is the responsibility of the California Employment Development Department, or EDD, to collect these payroll taxes, as well as enforce collection and conduct payroll tax audits of individual businesses. This classification determines the amount of payroll taxes that you pay, and any misclassification can mean that you are paying the EDD less money than you owe under the applicable laws. Obviously, this is a source of concern to the auditor. In addition, the IRS will very likely use the results of an EDD audit to assess its own taxes, interest and penalties on the federal level. In short, an unintentional misclassification of a single worker can end up being a costly mistake. First, you are responsible for withholding payroll taxes for an employee and paying employer payroll taxes, while an independent contractor is responsible for his or her own taxes. Second, simply put, determining who is an employee or independent contractor comes down to an issue of “direction and control”. Specifically, an employee has little to no control over how work is done, when work is done and where work is done. In addition, the work of an employee is controlled or supervised by a business owner or someone employed by a business owner for that purpose. This business owner or supervisor need only have the “right to control” for a worker to be regarded as an employee. An independent contractor does not labor under these restrictions. They largely maintain control over how, where and when the work is done, and they are not subject to direction or control. For example, a housekeeper or landscaper often works for multiple homeowners and businesses, provides their own tools and supplies and work when their schedule permits. It is very often a case by case factual determination.
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This means that misclassifying a worker can easily happen and when it does a single instance can cost a business thousands of dollars. Because unemployment is only available to employees of a business, this former worker is affirmatively claiming that they were an employee. Audits can also be triggered by filing payroll tax returns late, or paying payroll taxes late, paying workers in cash, firing a disgruntled worker who reports you to EDD, or not paying wages to workers timely. This notification is meant to put a business on notice that the EDD intends to audit their payroll taxes; and, it usually contains a list of documents that the auditor wants the business to produce, along with a list of questions that need to be answered before the actual audit begins. The list of pre-audit questions is to help the auditor come up with a game plan for the audit. It’s also designed to get you to make admissions regarding your specific payroll practices. Being difficult or obstructionist will only hurt your overall position. That being said, you don’t want to be too helpful. Giving an auditor more information than they have specifically asked for can be as dangerous as not giving the auditor enough information. However, if circumstances and evidence dictate, that three-year period can be extended further back in time. Keep in mind that an auditor may use these factors to gain a classification that works in favor of the EDD and against the interests of an individual business. Also keep in mind that even if the EDD classifies a worker one way, the IRS can classify that same worker differently, and vice versa. Payment is due within 30 days of demand. If full payment is not made within this time frame, a 10 penalty will be added to the amount owed. However, a taxpayer may appeal the EDD determination if the taxpayer believes it to be in error for one reason or another.
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If the EDD makes a finding of underpayment, the IRS will usually adopt the findings of the EDD and assess their own taxes, interest and penalties. An experienced California payroll tax attorney can help guide you through the audit process, using specific knowledge of employment tax laws, rules and case law to help you achieve the best possible results. Contact us today for a free and confidential consultation. In this article we spell out how to survive an EDD audit of your California business. Are you getting ready for an EDD audit. EDD audits can be scary, but there are many ways to protect yourself and prepare for the audit. The Employment Development Department, or EDD, are doing more and more audits on California business owners to try to find costly violations. If you didn’t knowingly do something wrong, you may not face serious consequences from the audit. But still, you’ll feel way more confident and secure if you know what you’re going into. In this guide, we’ll walk you through what to expect, and how to survive an EDD audit. Keep reading to learn what you need to survive an EDD audit of your business. Why Is My Company Getting Audited. You might be wondering why you were chosen for an audit. You think you are following every legal requirement, so what is the reason for this audit. To know how to handle the situation, you first need to figure out the type of audit that’s getting performed. There are two types of EDD audits. Knowing which one you’re looking at will affect how you get ready for yours. 1. Verification Audit Verification audits get initiated randomly. If you follow all the rules, you can still get flagged for this kind of audit, since they happen at random. There’s no assumption of problems or wrongdoing in this audit type. The selection criteria for a random verification audit includes your payroll size and number of employees.
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Your industry type, geographic location, and any combination of these factors can also raise or lower your chances of getting a verification audit. 2. Request Audit Facing a request audit is a bit more serious. In this case, your business was deliberately targeted for an audit because EDD investigators gathered information on it, or because information about your business and suspected violations was provided to the EDD and triggered an audit. Usually, the people who provide this information are current or former employees. They may have a legit grip against how you are running your business or they may be purposely looking for ways to exploit the situation and cash in on your dime. What Happens After You’re Audited So, you’ve been notified of the audit, and you’ve found out what kind of audit it is. What next? First, the auditor will send you a package. This package will contain the audit notice, a questionnaire to fill out before the audit, and a standardized request for your records covering the period that’s being audited. Sometimes, the auditor will also send a request to extend the statute of limitations. You need to make sure to share every correspondence that the EDD sends to you with a trusted legal representative. An audit doesn’t automatically spell disaster, but it’s not something you should face alone. Make sure to have your legal representative sign the EDD Power of Attorney. The EDD likely hasn’t looped your attorney in on their correspondences, so it’s up to you to notify them. Even when the audit is finished and the EDD sends its findings, your attorney probably won’t be kept in the loop. It’s up to you to let them know the outcome, too. Preparing for an Audit After you’ve gotten the audit notification, it’s time to get ready. You’ll need to get your records together. It’s crucial to be organized and well-prepared, which can help keep the fines and penalties to a minimum.
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Here are a few of the things to focus on as you get organized to prepare for the audit. Go Over Independent Contractor Agreements If you keep independent contractors as part of your business, one of the critical steps now is to go over the terms and conditions of any business agreements you made with them. If your business doesn’t have any written agreements with its contractors, this is a good time to start. One thing the EDD will consider during the audit is what the parties believe the nature of the working relationship is. The EDD’s goal is to figure out whether the individual’s relationship with the employer is that of employee or independent contractor. You’ll need to make sure certain provisions are in the agreements (or not in the agreements) to confirm that both parties have the same intentions for the working relationship. Certain terms are red flags for the EDD. For example, if you require contractors to work during a certain time of day, require that they attend company training’s or meetings, ask them to send in a time sheet, or keep them from working with other companies, this doesn’t point to a contractor relationship. TAKE NOTE: Almost nothing is considered an independent contractor by the State of California anymore. You will have a hard time proving Independent contractor status in most situations by this states standards of what it is. Get the Right Documentation During an EDD audit, it helps if you can prove that every contractor owns their own individual business. For this evidence, you’ll need copies of things like invoices, business cards, letterheads, or business licenses. Get one of these documents for every contractor who works with your business. Sometimes, you’ll be able to get these documents once the audit process has already started. However, it looks better to the auditor if you already have them beforehand. Plus, if you’re no longer working with those contractors, it will take you longer to get the documentation you need.
File Tax Returns On Time Another way to stay prepared for an audit is to file your quarterly employment tax returns in a timely manner. Make sure to work to get those tax returns in before the due date arrives. If you fail to meet those tax deadlines, it’s a sign of poor organization, which doesn’t look good in the eyes of an auditor. And you might end up with a tax liability that you weren’t expecting. Be Prepared For an EDD Audit The final step in an EDD audit is actually meeting with the auditor. After you’ve gotten your records together and talked with your attorney, you’ll be ready for the audit. If you got your records in order and went over things with a legal representative, the audit itself could be relatively painless. But if they do claim violations you may find yourself on the hook for costly penalties, lots of stress and uncertainty about the future of your business. If you have been notified of a California EDD Audit remember you don’t have to face it alone. We have top level attorneys who protect and defend California business owners like you every day. Give us a call for a FREE CONSULTATION. Free Ebook! 6 Tips To Protecting Your CA Business From Employee Lawsuits Download now and start protecting your business I agree to have my personal information transfered to MailChimp ( more information ) I will never give away, trade or sell your email address. You can unsubscribe at any time. (Visited 102 times, 1 visits today) Summary Article Name How to Survive an EDD Audit of Your California Business Description Read this article to learn how to survive a California EDD Audit on your business. Author John Fagerholm Publisher Name DefendMyBiz Publisher Logo A LAW FIRM DEDICATED TO ONE MISSION: GIVING YOU THE CALIFORNIA EMPLOYER A FIGHTING CHANCE. We're changing the image of California being a bad place to be an employer, by dedicating our practice to standing up for business owners.
We promise to do everything we can to protect your rights and get you back to what you should be focusing on; your business. GET AN ANSWER TO YOUR EMPLOYEE PROBLEM NOW Privacy Policy Terms and Conditions Contact Us Sitemap Charity Copyright 2015. The EDD preliminary audit notice will inform your client of the audit period.If your client was not incorporated, any resulting EDD status determination will be directly assessed against your client. He or she will be personally liable; a husband and wife will have joint and several liability. A status audit is the most common type of EDD audit these days and involves the central issue of whether workers are employees or independent contractors. If your client was incorporated during the period covered by the audit, the corporation, as a separate entity will be liable. Your client will not be personally liable. It will be up to the EDD, at some time in the future, to make the determination whether to issue an assessment against those individuals whom the EDD believes were “responsible persons”. This question is critical because it will determine just how far back the EDD and the IRS may examine books and records. We will discuss the IRS at a later time. Let’s focus on the EDD. That section is California Unemployment Insurance Code Section 1132 (you can refer to this code as CUIC). Whether the EDD makes an assessment against your client as an individual, corporation, or both, it must do so within the language of this code section. Let’s start with the basic rule: If your client has filed quarterly EDD employment tax returns, the statute of limitations for assessment is anytime up to three years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued or within three years after the deficient return was file, whichever was later.
If your client has failed to file returns because all workers had been treated as independent contractors, including the owners of the corporation, the statute of limitations for assessment is anytime up to eight years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued. This is an important difference between EDD and IRS rules. Under IRS rules, if no return is filed, there is no statute of limitations for examination. If the EDD suspects fraud, whether or not a return has been filed, there is no statute of limitations for assessment. You have the duty in effectively representing your client to inform the auditor that the statute of limitations for these periods has already expired and, therefore, your client does not have to go through the inconvenience and expense of reproducing records for an already expired quarter or two. During the audit you must be constantly diligent about the statute of limitations. Why? EDD audits can drag out for a long time and it is not uncommon for the statute of limitations to expire on one or more quarters during the audit process. The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.The information provided on this site is not legal advice, does not constitute a lawyer referral service, and no attorney-client or confidential relationship is or should be formed by the use of this site. The attorney listings on the site are paid attorney advertisements. I have been representing clients before the EDD since the 1980s. While the faces of the auditors change, and management is replaced with very competent and experience former EDD auditors, the nature of an EDD audit has remained constant.
The issue of control in a worker relationship is as relevant today as it was 30 years ago. While the auditor may not be familiar with the intricacies of a specific business, the factors governing worker control have remained essentially unchanged. However, the 23 factors are always present in every revision. Those 23 factors are used by auditors to determine the quantum of control. (The IRS continues to use its famous “20 factor” test.) These tests cannot be compared to a child’s game of marbles where the one who gathers the most marbles wins. I have seen many cases where an employer can have the majority of factors in its favor and the EDD will have only a handful of factors in its favor. Guess who wins? It’s not the employer. This is why I try to dissuade clients from feeling over confident when, after they read the 23 factors, they are empowered and believe they will automatically win. The client may not win the battle. While Administrative Law Judges of the CUIAB try to be objective, I have found that certain factors carry more weight than others, resulting in a victory for the EDD and a loss for the employer. But how do you define control. Many times control depends upon the skill levels of the workers and the degree of employer-supervision required. For example, farm workers and fruit pickers are relatively unskilled and require a great deal of supervision. It is clear that these types of workers should be classified as employees. On the other hand, physicians working in a hospital emergency room are highly educated, highly trained and licensed by the State of California. This is why a law was passed classifying them as independent contractors and not hospital employees. What about lawyers doing research for a law firm or who handle court appearances. They too are highly educated and licensed by the State. Yet they are treated by the EDD as employees of the law firm. As you can see from these examples logic has almost no place in an EDD audit.
In the introduction of Part 1, I gave three examples of businesses that are essentially commercial matchmakers or third party logistics companies. Yet the EDD will usually conclude that these business relationships are, for the most part, that of employer-employee. What I’m saying is that logic and common sense are not so common in a typical EDD audit. They don’t win the day. Keep in mind that in virtually every business relationship there is lurking a certain amount of control. This control, by itself, is not necessarily fatal. The presence of control is not ipso-facto fatal to the employer. In Part 3 we will explore these Borello factors and determine the relative weight of each of them. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House. We also serve clients in other communities in Los Angeles County, San Diego County, Orange County, Ventura County, Riverside County and throughout the San Fernando Valley, South Bay and Southern California. How should my team and I prepare. Any lessons learned would be greatly appreciated. Or is this something else (Federal?) -- needs defining. I'll assume this is CA or some other state employment department. In which case, to answer your request, I went through a state employment audit last year. Not too painful -- more an annoyance. We had previously hired some young summer interns at various times and paid them by the hour by gross check to do some minor tasks like labeling, on an as-needed basis.Thank you, Lee, great answer.
EDD auditors are only interested in assuring that your company properly reported, withheld, and timely remitted all required employment taxes and earnings reports of all employees. It's usually little different than a worker's comp payroll audit. But don't let that make you complacent or feel like you can challenge them. You need to treat them respectfully and pretend they are smarter than you are or risk the consequences of them focusing their energies on making your life miserable. They do have pretty impressive powers. But, it almost never is. It's referring to payroll taxes that were not paid. It's also a good way to assure that a business will not survive the long run. It's the denizen of self employed business people. It is usually the start of a downward spiral. I'm no fan of government overregulation or the burden that places on businesses. But purposely ignoring or being unaware of the employment laws and tax consequences of independent contractor vs employee is something I might expect from the accountant at Fred's Discount Painting Service and not from a CFO at a serious firm. Laughing off the small fine imposed in that particular case might lead to something much more serious later on. There are liabilities beyond payroll taxes for not getting the employment relationship right. They were looking for 1099 contractors that were Employees. They may be leading the way for other states. For example, if they should have been w-2 then you should have withheld, paid into social security, medicare etc. Maybe they should get 401K, stock options, profit sharing. This is a long list, and yes, it can shut companies down if it is more than a minor thing. And, do not be cavalier if the initial scope is minor; you may have to open the kimono, looking into overtime, withholding rates, etc.
2) Very often EDD comes in because there is cause: a contractor is dismissed and files for unemployement; there is a worker's comp claim; you simply have lots of low-paid employees on 1099s. You should find this out. What triggered it? Is it random, or is there a red flag that you need to be aware of? 2) Investigate internally. The easy part is confirming that your payroll provider and worker's comp provider are doing their jobs, and that you haven't mis-classed anyone. Then check your contractors. There is no set rule, so this can be quite fraught if you have many independent contractors on your payroll. Try looking at them with the most critical eye possible. 3) Build your case of documentation as to what you've paid to whom and why; what are and aren't employees, etc. If you are defending IC status, make sure that you can provide a preponderance of evidence that they are in fact ICs. 4) Have a nice, productive and open meeting with the Auditor, with nicely sorted documentation. They will (in my experience) be grateful that you are open and informative. They are generally nice people trying to keep the playing field level for us; the less of their time we waste, the more time they can devote to hunting down people who are actually on the wrong side of the rules. You can withdraw your consent at any time. Learn more. In a nutshell, federal law is more generous in limiting IRS reclassification of independent contractors and in options to reduce potential liability than offered by the EDD, but requires diligence in either event to assert rights. On the appeals side, businesses may overlook the necessity to affirmatively pursue cases. With EDD appeals businesses may not realize that ALJ proceedings are not before a court and require at the ALJ level full pursuit of rights as the CUIAB second appeal does allow new document production as permitted before the Tax Court.
Commonality of IRS and EDD Businesses hire an outside contractor rather than an employee for many reasons. Special expertise is one reason. Another related reason is limited resources make more cost effective to contract for an outside service as needed, rather than to have permanent staffing. On the other hand, both the IRS and the EDD are concerned whether businesses are trying to avoid the costs of employment, including avoiding employer payroll tax liability 1. Compounding this is the fact that a worker’s classification is not always clear. For example, example, assume an outside software engineer is hired to develop a software module that will regulate air intake for a carburetor. That module is critical to the overall function of a soon-to-be completed software program to operate the vehicle electronic system. To assure that the module fits into the program, the auto maker may require a particular program language be used, that it be compatible with other software components and that the module works correctly. While in Detroit, an auto maker’s specifying highly exacting parts requirements from suppliers will not turn suppliers into employees, within nearly the same context, the IRS and EDD may disagree as to services. Section 530 Safe Harbor Given these uncertainties, for nearly 40-years, Section 530 of the Revenue Act of 1978 (Section 530) mandates that the IRS may not retroactively reclassify independent contractors as employees or impose federal employment taxes, penalties and interest if the hiring business: Consistently treated the workers (and similarly situated workers) as independent contractors; Complied with the Form 1099 reporting requirements with respect to the compensation paid the workers for the tax years at issue; 2 and Had a reasonable basis for treating the workers as independent contractors.
Accordingly, for federal employment tax purposes only, the IRS will not reclassify a worker as an independent contractor where the original classification had a reasonable basis. Interestingly, a custom of practice does not require that all workers in the industry be treated the same. For example, certain sports coaches may be considered independent contractors, and not employees, wherein the community is split on their classification. Under the Small Business Job Protection Act, it is substantial if 25 of the community can be shown to be treating workers as independent contractors. In determining the reasonable basis, the fact that workers are employees for state unemployment tax or wage and hour law requirements will not make section 530 inapplicable. By contrast, the EDD provides no such Section 530 safe harbor. This means that even where legal advice was rendered or the practice has been to treat workers as independent contractors, the EDD may still reclassify workers as employees. In addition, the IRS and EDD may share information, wherein the outcome by the EDD may differ from that of the IRS. Reduced Assessments Even where a worker is classified as an employee, there are provisions where the IRS grants reduced liability. Under Internal Revenue Code Section 3509, the employer liability for a misclassification error is partly reduced. While there is no direct abatement of the employer portion, as to the employee withheld portion, under Section 3509, the liability is reduced to 20 of the 7.65 percent employee withheld social security liability. The effective rate is then only 1.53. In addition, the employer liability for failure to withhold is reduced to 1.5 of wages. However, the employer portion of taxes is not reduced. Because these reductions are significant, Section 3509 relief is often the preferred choice and is permitted provided that the employer is no to found to have intentionally disregarded the requirement to deduct and withhold tax.
There is no reduction to the employer liability for failure to withhold where an individual was reclassified as an independent contractor. However, the EDD allows businesses to claim a credit or to eliminate liability for failure to withhold wages where reclassified workers voluntarily submit a Form DE938P, permitting the EDD auditor to review and confirm that all wages were reported by the worker on his or her return and personal income taxes were paid. This closes out payroll withholding liability for state income taxes. Liability is then limited to the remaining state payroll taxes imposed, namely taxes otherwise withheld or charged for state unemployment insurance, state disability insurance and the employee training tax. In addition, the EDD is not alone in issuing penalties. Compliance Settlement Program In addition, the IRS provides two additional provisions for relief, the Compliance Settlement Program and the Voluntary Compliance Settlement Program. Each of these programs was updated in December 2017, to provide for greater relief. Taxpayers must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS. The application should be filed at least 60 days prior to the date the taxpayer wants to begin treating its workers as employees. The IRS will make every effort to process Form 8952 with sufficient time to allow for the voluntary reclassification on the requested date. The regular Compliance Settlement Program is available to taxpayers to obtain relief during an audit examination. The business must have filed timely 1099s and may fall under one of several options. First, if the taxpayer is entitled by custom to classify workers as independent contractors, the program is optional because the IRS cannot assess a tax.