If you’re a business owner and taxpayer in California, you may have heard the term EDD audit recently. Or perhaps you’ve faced this tax audit first-hand.

If you’re not familiar with the term, an EDD 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.

Why is this important? Because 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. And if you’ve ever hired an independent contractor, you could be facing this tax audit.

In a recent blog post, I explained how the state of California can make this classification and how you will know if you’re facing an EDD audit. In this post, I’m sharing what you should do if you receive a notice of audit and what you may be facing.

I just received an EDD audit notice. What should I do?
The first step you should take is to contact a tax attorney, preferably one who has experience with EDD audits. The attorney should advise you to gather your records and other relevant documents in order. Having these documents organized will be a big help in your defense. The more documentation you are able to present in your defense, the easier it will be to get you through the audit process successfully.

What kind of records should I gather? What documents will the EDD want me to provide?
The most common records the EDD requests during an audit are general employment questionnaire, payroll records, federal income tax return, bank statements, wage information for particular time frames, and employee registers. After these documents are requested, the actual audit begins and the EDD may request other additional documents.

How do I show the independent contractor I hired is not actually an employee?
This question depends on many factors, including your industry, the type of work you do, and how you treat the person working for you. The EDD will look for things such as whether you asked the contractor to work certain days and times, if you have signed contractors if you required them to attend company meetings or trainings, or if you did not want them working for other companies.

What are the penalties associated with EDD audits?
Depending on the reason for your EDD audit, you could be liable to face a wide range of fines that can cause you a considerable amount of financial strain. These sorts of fines include a percentage of unpaid taxes, set dollar amounts for each case of unreported employees or independent contractors, and much more. These fines are why you need an experienced tax attorney to review the audit and potential penalties.

What happens if I don’t agree with the proposed assessment from the EDD?
If you don’t agree with the proposed assessment the EDD gives you after their audit is complete, your tax attorney can help you appeal the assessment.

California payroll tax audits can be scary! Especially for small business owners and taxpayers who have a lot on the line financially. Don’t assume you have to handle this burden on your own. Contact a tax attorney who can 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.