Why Should I Care About an EDD Audit?
Did you know that as a business owner, you can be held personally liable for payroll taxes of workers you consider to be independent contractors?
That’s right! If you’re a San Francisco business owner and you’ve ever hired an independent contractor, you may want to familiarize your practice with the EDD audit. These California Employment Development Department (EDD) state payroll audits occur when a business has classified a worker as an independent contractor instead of an employee. This means the business owner can be liable for “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees.
As a tax attorney who has represented clients through hundreds of EDD audits, I’ve worked with several San Francisco businesses that ask me about the audit process. Here’s a look at why you need to care about being audited by the EDD.
How does the state of California make this classification?
California generally encourages workers to be classified as employees to protect them. They want the worker to be covered by worker’s compensation and have the right to collect unemployment if they were to lose their job.
Most EDD audits start when a worker files for unemployment and the business receives a three-page letter that may seem very vague and inconspicuous. This is the start of the EDD audit, so DO NOT ignore this letter! Businesses must follow the California ABC Test to classify an individual as a 1099 independent contractor rather than an employee. The ABC Test states that all three of the following questions must have a “yes” answer in order to classify an individual as an independent contractor:
- The worker is free from the control and direction of the hirer in relation to the performance of the work, both under the contract and in fact;
- The worker performs work that is outside of the usual course of the hirer’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed by the hirer.
If you want to determine whether there is a trigger for the EDD to audit your business, a good practice is to answer these questions. If you cannot answer “yes” to all three of these questions – and you’ve classified the individual as an independent contractor and not an employee – chances are you may face an EDD audit in the foreseeable future.
If you do not respond to an EDD audit notice, the EDD has been known to make a determination based upon the type of industry, the historical payroll of the company or the number of 1099s issued. The EDD will then send out a proposed assessment. If the company does not respond to that notice, contest it, or provide additional documentation by the deadline, then the balance due will eventually be sent to the collections department.
I’ve seen some very sophisticated business owners and private practitioners try to go back to the assessment side and have an agent adjust the audit results. However, what they do not realize is that the left-hand does not talk to the right hand at the EDD. The agent on the assessment side may be working with you, while the collection side is still trying to collect the balance due.
Receiving an EDD audit notice is confusing, especially for San Francisco small business owners who have a lot at stake. Knowing what to expect and handling the request with a tax attorney experienced in EDD audits will help you navigate the murky waters of the EDD audit.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
