One of the biggest issues facing California business owners and taxpayers this year is whether they will be faced with an 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 EDD can personally assess the business owner for “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees.

How does the EDD make this classification?

You’re probably wondering how a government department can make such a big decision about your company and the people you employ. It started in 2018 when the California Supreme Court ruled on a case called Dynamex Operations West, Inc. v. Superior Court of Los Angeles. This case ruling created the California ABC Test, which narrows an individual’s ability to be classified as a 1099 independent contractor.

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:

  1. 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;
  2. The worker performs work that is outside of the usual course of the hirer’s business; and
  3. 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 cannot answer “yes” to all three of the above questions, the individual will be classified as an employee. That means you, as the business owner, will be held responsible for unpaid payroll taxes for that employee.

If you employ independent contractors as part of your business, the first thing you should do is review the ABC Test questions with an experienced tax attorney. While you may think you can answer the questions yourself, the EDD can be complicated and may have specific criteria for specific lines of work to help classify contractors as employees. Additionally, do not wait until you receive a notice of EDD audit before reviewing the ABC Test questions. A tax attorney can help you navigate the EDD to best serve you and your business.

Allison Soares is a partner and tax attorney at Vanst Law. 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.