Most taxpayers and business owners are unaware they can be held personally liable for payroll taxes of workers they consider to be independent contractors.

Because of a recent case ruling – Dynamex Operations West, Inc. v. Superior Court of Los Angeles – the California Employment Development Department (EDD) is getting stricter with conducting these investigations, which are essentially workers re-classification audits.

These California state payroll tax audits (commonly referred to as an EDD audit) 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 can the state of California make this classification, you ask?

They do this because 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.

This is very confusing and frustrating to you as the business owner. It is helpful to discuss the situation with our experienced EDD audit lawyer.

But you need to be aware that if you’ve ever hired an independent contractor, you could be facing this tax audit. And if you don’t know how to protect yourself and your practice, you could be facing a huge financial burden.

You are probably asking yourself how will you know if you’re facing a California state payroll tax audit.

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!

If an EDD audit notice sits in a pile and no one responds to it, 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 react to the EDD notice. They try to go back to the assessment side and have an agent adjust the audit results. However, they don’t realize that the left-hand doesn’t 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 a California payroll tax audit is a confusing and scary matter, especially for small business owners who have a lot at stake. Knowing what to expect and handling the request with a competent lawyer and tax attorney will help you navigate the murky waters of the EDD audit.

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.