Many California business owners have been faced with a new challenge over the last year, and that is the EDD audit. This type of audit occurs when the California Employment Development Department (EDD) launches an investigation into a business’ California state payroll tax records to determine if the business has classified a worker as an independent contractor instead of an employee.
Since so many companies use independent and freelance contractors for business, this audit has far-reaching effects. If the EDD determines they believe those workers are actually employees, the EDD can personally assess the business owner for “unpaid” payroll taxes. And if you’ve ever hired an independent contractor, you could be facing this tax audit.
Business owners often ask what the statute of limitations is, or how long the EDD has to audit a company. According to Section 1132 of the Unemployment Insurance Code:
“Except in the case of failure without good cause to file a return or report, fraud or intent to evade any provision of this division or authorized regulations, every notice of assessment shall be made within three years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued or within three years after the deficient return or report is filed, or was due, whichever period expires the later. . . .
“In case of failure without good cause to file a return or report, every notice of assessment shall be made within eight years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued.”
Based on the code, the statute of limitations for an EDD audit to occur is three years. That being said, in some circumstances, the EDD can extend the statute of limitations to eight years when there’s evidence of fraud or faulty tax returns filed. 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.
Once that Notice has been completed, the time to complete the audit varies by situation. You’ll need to gather all the necessary documents for the audit, which may include bank and financial statements from the business for a specific time and period. It may also include copies of checks, check registers, ledgers, journals, pay records, 1099s, W-2s, and EDD’s Quarterly Contribution Return and Report of Wages (Forms DE-9 and DE-9C). The questions are written to root out the payroll practices of business owners, and serve as bait for the EDD audit in knowing how to approach the main audit carried out later.
It’s always wise to consult with a tax attorney, preferably one who has experience with EDD audits, 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. 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.