If you’re a California business owner and taxpayer, and if you’ve ever hired an independent contractor, then you should be familiar with an 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.

Many business owners ask how the EDD is even familiar with the daily workings of California small businesses and know how to start the audit process. Typically what happens to trigger an EDD audit is an independent contractor files for unemployment. Independent contractors are not eligible for unemployment benefits; so their claim triggers the EDD to look into the business practice.

Are EDD audits random?

The EDD typically does not randomly select businesses to audit because the process itself starts with a contractor filing for unemployment. That trigger is what initiates the audit process.

Businesses must follow the California ABC Test to classify an individual as a 1099 independent contractor rather than an employee. The Test came out of the 2018 California Supreme Court case, Dynamex Operations West, Inc. v. Superior Court of Los Angeles. 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 business, a good practice is to answer these questions. If you cannot answer “yes” to all three of these questions – and you’ve classified the individual as an indepdent 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 business is speak to a tax attorney with experience in EDD audits.

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.