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ASK THE EDD ATTORNEY – WHEN THE EDD GOES ON A “FISHING TRIP” – WHAT YOU NEED TO KNOW

By Robert S. Schriebman
September 25, 2015

Introduction

The EDD seems to be expanding its traditional standard operating procedures in worker status audits. What has traditionally been an inquiry into the primary issue of employee vs. independent contractor status is now expanding into searches for hidden additional compensation paid to corporate and LLC shareholders and members. The EDD seems to be looking for every possible dollar it can extract. In this article we will look at how the EDD has expanded its audit operations. We will also discuss the standard that the EDD must follow in conducting a legal audit.

How The EDD Is Expanding Its Audit Operations

I am going to set forth actual cases showing how the EDD is functioning these days. EDD auditors, in addition to asking for "the usual suspects" such as W2s, 1099s, general ledgers, and tax returns, are now asking for more intrusive documentation and information such as credit card statements, medical and dental expenditures paid on behalf of corporate officers and LLC members, as well as the personal use of company owned vehicles.

Credit Card Inquiries

Example #1: In the EDD audit of a small law firm LLC, the auditor asked for 3 years of credit card statements. Without asking about the nature and business purpose of selected charges, the auditor summarily treated all 3 years of credit card charges as additional compensation to the officers of the firm. It took quite an effort to convince the auditor's supervisor that at least 90% of the credit card charges were directly related to law firm's business operations. Needless to say the final Notice of Assessment was a drastic reduction from the amount set forth in the Proposed Notice of Assessment.

Example #2: In the EDD audit of a small "Mom and Pop" S Corporation, the EDD auditor concluded that each and every credit card payment made through a credit card, in the name of the husband alone, should be treated as a disallowed corporate expenditure. The wife was the President and CEO of this small operation. The auditor took the position that the credit card had to be in the name of the corporation. The auditor was not interested in any proof that any expenditure was for an ordinary, necessary, and reasonable business purpose.

Why is the EDD attacking credit card expenditures? Because a disallowed expenditure is additional compensation paid to a corporate officer. And additional compensation yields additional payroll taxes.

Medical and Dental Expenses

The EDD wants to treat corporate and LLC payments of medical and dental expenses, paid on behalf of officers and shareholders, as additional compensation. And additional compensation yields additional payroll taxes.

Personal Use of Business Owned Vehicles

To the EDD it's all the same bag. If the business allows an officer or shareholder to use a corporate-owned vehicle on weekends, holidays, or even commuting back and forth to work, the personal use of the vehicle constitutes additional compensation. And additional compensation yields additional payroll taxes.

It's All A "Fishing Trip"

I firmly believe in being cooperative in any tax audit. My goal is to generate as much good will as possible between the EDD auditor and the client under examination. However, there is a line, a blurry line, between cooperation and a potential economic disaster resulting from an audit gone out-of-control. One of the jobs of the any professional representing a client in an audit is to attempt to control the scope of the examination. At the same time no one wants to be labeled as uncooperative. Administrative Law Judges frown on uncooperative taxpayers. In today's EDD audit climate a representative is constantly juggling many factors. A representative must cooperate with the legitimate inquiries of the EDD auditor but at the same time prohibit "fishing trips."

EDD "Fishing Trips" and the U.S. Supreme Court

In 1964 the U.S. Supreme Court issued the famous Powell decision (U.S. v. Powell, 64-2 USTC 9858, 379 U.S. 48, 85 SCt 248 (1964.)) The case involved the interpretation of Internal Revenue Code § 7602. The IRS issued a summons for certain information that the taxpayer felt was improper. The Court issued 4 standards that must be met before any taxing agency can request information and documentation, as follows:

  1. The audit must be conducted pursuant to a legitimate purpose.
  2. The testimony or documentation sought may be relevant to that legitimate purpose. In other words, it is information which "might throw light upon the EDD inquiry."
  3. The information the EDD wants must not already be in its possession.
  4. The EDD needs to take the required administrative steps before the request can be issued.

Conclusion

The key factor in any request by the EDD for information and documentation is relevancy. I firmly believe that the primary EDD objective is to determine worker status not to find as much hidden compensation as possible. EDD audits have become battlegrounds between the demands of the EDD and the protection of the taxpayer from unnecessary intrusion. The future is unclear, but it is shaping up to be a battle of wills.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure", both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure", both published by Commerce Clearing House.

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