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ASK THE EDD LAWYER – LATEST IRS PRESS RELEASE ON WHAT THE IRS IS LOOKING FOR IN AN INDEPENDENT CONTRACTOR AUDIT. WILL THE EDD GO ALONG?

By Robert S. Schriebman
2017

Introduction

On May 2, 2017 the IRS issued a Press Release known as The Small Business Tax Tip 2017-2 "Employee or Independent Contractor? Know the Rules." (2017ARD 086-3).

An employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Employers normally do not have to withhold or pay any taxes on payments to independent contractors.

The key points that employers must focus on, according to the Press Release, are control and relationship. This article will discuss these two factors. In addition I will also discuss whether or not current EDD audit practices dovetail into and are in sync with the IRS. In my opinion, they are not working together.

Control

Perhaps the most important element in all of this is control. As far as the EDD is concerned there does not have to be actual control. To the EDD, the "right to control" is actually more important than control itself when it comes to assessing EDD taxes. The IRS may cut the employer some slack here. Only if the business actually directs or controls financial and certain relevant aspects of a worker’s job, the employer exercises what the IRS refers to "financial control." The EDD does not want to acknowledge the realities of the business world. You see, in every business relationship, there will always be some element of the right to control present.

The following factors are considered financial control by the IRS.

  • The extent of the worker’s investment in the facilities or tools used in performing services
  • The extent to which the worker makes his or her services available to the relevant market
  • How the business pays the worker, and
  • The extent to which the worker can realize a profit or incur a loss.

Does the EDD use the same factors as the IRS? Most EDD audits, that I have participated in, do emphasize a worker’s investment in the tools of his or her trade, and risk of loss. The EDD does not particularly factor in how a worker is paid other than payment on a weekly basis indicates that the worker is an employee. EDD auditors generally do not conduct a thorough enough examination to analyze and determine the workers pursuit of business in the public arena. I have had contractors classified as employees when it’s clear they have received from the employer such a small amount of compensation that they could not possibly survive without getting business from the general population. It is so obvious, but so ignored by the EDD.

Relationship

The IRS will also take into consideration how the employer and worker perceive their relationship. Key IRS factors are as follows:

  • Written contracts describing the relationship the parties intended to create
  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay
  • The permanency of the relationship
  • The extent to which services performed by the worker are a key aspect of the regular business of the company, and
  • The extent to which the worker has unreimbursed business expenses.

Does the EDD go along with the IRS? No way! I have yet to see an EDD audit where a written contract between the parties is honored by the EDD. That’s not right! I refuse to prepare any contract for any fee because I know that no matter what I draft, or how I draft it, the EDD will not respect it. Employee benefits such as health insurance premiums are included as additional compensation for owners of LLCs. If the services provided by the worker are deemed essential to the business, that worker is an automatic employee as far as the EDD is concerned.

Conclusion

For the average small to medium-sized business there is now, and there will be in the future, a "whipsaw" treatment of worker status relationships between the IRS and the EDD. What the IRS will allow, the EDD may throw out the window. Employers continue to be under the mistaken impression that the "safe harbor" rules of Section 530, honored by the IRS, will also be honored by the EDD. The EDD has no Section 530 "safe harbors."

With the EDD now hiring more new auditors, things are going to get a lot more confusing and expensive.

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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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