Construction companies are just one of the many businesses facing the prospect of an EDD audits. If you’re a construction company 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 the EDD audit process, I’ve worked with several construction companies who ask me about the audit process. Here’s a brief outline of the EDD audit process and how it begins.

Are EDD audits random?

Generally, the EDD does not randomly select businesses to audit because the process itself starts with an independent contractor filing for unemployment. Independent contractors are not eligible for unemployment benefits; so their claim triggers the EDD to look into the business practice. Businesses, including construction companies, 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:

  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 want to determine whether there is a trigger for the EDD to audit your construction company, a good process 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.

EDD audits can be confusing, especially when they involve a former employee or independent contractor and you’re not sure what triggers the process. Don’t try to work with the EDD yourself. The best thing you can do to protect your construction business is to speak to a tax attorney with experience in EDD audits.

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.