Why Should You Have Concerns about a California State Payroll Tax Audit?
Most taxpayers and business owners do not know that they can be held personally liable for the payroll taxes of their business, even if it is a separate corporation. The EDD handles audits and collection of payroll taxes and maintains employment records for more than 17 million California workers. Most EDD audits are worker re-classification audits that occur when a business has classified a worker as an independent contractor instead of an employee. This classification occurs when the business owner does not believe that they exercise “control” over the worker and therefore they are not an employee. However, California generally encourages workers to be classified as employees to protect the workers. They want the worker to be covered by worker’s compensation and have the right to collect unemployment if they were to lose their employment.
Most EDD audits start when they send a letter to a business owner or taxpayer that may seem very vague and inconspicuous. It is a 3-page letter and sometimes it is even difficult to determine what years the EDD wants to audit. As opposed to an IRS audit notice, which is generally very detailed; stating the years and the line items that you need to substantiate for the IRS audit. After the 3-year audit, the agent may re-classify some of the workers to employees. Since, a business with employees is required to withhold payroll taxes from an employee’s paycheck and to pay applicable federal, state and local taxes, the business will then receive a proposed assessment. If it is not appealed or contested, the balance due will be transferred to the collections department.
However, with state payroll taxes, similar to the IRS trust fund recovery penalty, the EDD can personally assess the responsible parties who willfully did not pay the payroll tax liability. This generally means that the business owner could be personally responsible for these “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees. This is very confusing and frustrating to many business owners and taxpayers, they set up a separate legal entity for legal protection from any individual liability.
If you receive an EDD notice, it is very important to take it seriously and make sure you contact the EDD within the time-frame allotted. Contact an experienced tax professional or attorney to help you obtain a quick resolution.
