Since the pandemic started to ease slightly in 2021, the Employment Development Department (EDD) accelerated their audits on California businesses. An EDD audit is a state payroll audit that generally occurs when a business has classified a worker as an independent contractor instead of an employee. Most concerning is the EDD has expanded their typical audit time of three years (12 quarters) to a maximum of eight years. One way to avoid an audit that can potentially go back eight years is to make sure your employees are on payroll.
According to Section 1132 of the Unemployment Insurance Code, the EDD can extend the statute of limitations to eight years when there’s evidence of fraud or faulty tax returns filed. EDD audits are focused on reclassifying independent contractors to employees. An auditor is going to look for red flags that prove those contractors should have been on payroll as an employee. This is why payroll is so important.
Even if you are the only person in the business, it’s better to put yourself on payroll than having no employees on payroll at all. If the EDD sees that an employer regularly files quarterly payroll tax returns, that may stave off an audit or at least assure it stays within the regular period of three years, rather than eight.
One of the reasons EDD audits come down to payroll is because in California, payroll taxes are much higher compared to those of other states. The EDD ensures payroll tax audits of companies and businesses are being carried out. This is why having your contractors and employees — even just you as the business owner — on payroll is a way to protect yourself and your business from harm resulting from an EDD audit.
You will know if you’re receiving an EDD audit if you receive a Notice of Assessment in the mail. Typically, that notice must be issued within three years after the day of the month following the close of the calendar quarter during which the liability occurred. However, if the EDD suspects fraud or misreporting, they can extend the audit period to eight years.
As an experienced tax attorney who has worked on numerous EDD audits, I advise my clients to first and foremost get your company and employees on payroll. And do that as soon as possible. If you then receive an audit notice, contact a tax attorney before trying to tackle the EDD process yourself. A few extra steps at the beginning of the audit process can help you significantly in the long run.
Allison Soares is a partner and tax attorney at Vanst Law. Before starting her own practice, Soares was a partner at a tax law firm where she honed her skills handling a wide variety of tax and employment-related cases. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.
