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ASK THE EDD LAWYER - HOW TO BE PREPARED FOR AN EDD AUDIT "ENTRANCE INTERVIEW" Part 2

By Robert S. Schriebman
May 11, 2016

Introduction

This is Part 2 of a several part series of articles dealing with EDD probing questions on an initial "first impression" Entrance Interview. EDD auditors always try to conduct an entrance interview as the first phase of a worker status audit. The taxpayer-employer's presence is required for an entrance interview. The goal of the EDD is to gather as much potentially damaging information as possible. This is why I make it a practice to avoid my client being subjected to this process.

In this series of articles I will set forth verbatim each and every interview question on the EDD's agenda. I am sure that the EDD believes all of the questions listed in the "Entrance Interview" questionnaire are necessary, proper and relevant. Many interview questions are as the EDD perceives them to be. However, from my point of view many questions are vague and potentially dangerous to you.

It is my goal, in setting forth these questions, to give you insight and to allow you to get a "heads-up" so-to-speak. A knowledgeable taxpayer is a prepared taxpayer.

The following questions are taken verbatim from a multi-page "Entrance Interview" Matrix.

Questions Relating To Your Business Operation and Business Entity

  • What Licenses are required to operate your business (Provide Copies)?

    Bob's comment: This is a proper inquiry for the EDD auditor to make. While you are producing a copy of your business license, it is important to obtain copies of the business licenses for those who receive 1099s. This is especially crucial for general contractors who are licensed by the CSLB. You should also produce copies of CSLB licenses from sub-contractors. If a licensed general contractor hires unlicensed sub-contractors they are by law automatically treated as W2 wage earners.

    If you use a handyman you should also obtain a copy of his or her city business license.

    Some cities however do not require a license for certain occupations.

    One of the biggest stumbling blocks in an EDD audit is the absence of a business license and especially a federal employer-identification-number (EIN).

  • What is the legal name of the business? If there is a D.B.A. what is it?

    Bob's comment: Most EDD auditors will treat a worker as an independent contractor if they have taken the steps necessary to hold themselves out to the public to be in business for themselves. A DBA for an unincorporated person is a smart thing to have. However along with the DBA, the worker should also have an IRS issued EIN. In that way when you issue a 1099 it is not to an individual with a social security number. The 1099 should be issued to someone with a DBA, corporation, or LLC along with an EIN.

  • What entity types has the business had throughout the statutory audit period? (Refer to most recent completed 12 quarters) What is the current entity type?

    Bob's comment: In the following series of questions lurks the danger of expanding the EDD audit to other entities owned or controlled. A multiple audit is known as a "Horizontal Audit." This type of audit can involve a greatly expanded intrusion and significantly higher assessments.

    a) If this is a Sole Proprietorship/General Partnership, does a husband/wife, and/or children older than 18 years old work within the business?

    Bob's comment: Doing business a sole proprietor or general partnership these days is operating in the dark ages. As a sole proprietor or general partner you are personally liable for any or all EDD and IRS payroll tax assessments of your business. With an LLC or Corporation your chances of personal exposure are minimized.

    b) If this is a LLC, who are the managing members and what percentage of ownership does each have? How does the bussiness file the federal tax return 1065 Partnership Return or 1120 Corporate Return?

    Bob's comment: LLCs are treated as corporations for employment and withholding tax purposes. Under CUIC § 1735 the EDD can ignore the LLC, assess payroll taxes, and collect every dime of LLC level from those who control the day-to-day fiscal affairs of the LLC. While this is a relatively rare occurrence, if it happens to you it will ruin your day!

    c) If this is a C-Corp or S-Corp, who are the corporate officers and do they take a salary? If the corporate officers don't take a salary how do they support their livelihood?

    Bob's comment: We see this all the time - corporate officers who take money out of the business but give themselves a 1099. This is illegal. Corporate officers, by both IRS and EDD law are statutory employees.

    There are numerous problems involving distributions from S Corporations that are not reported as W2 wages. Unfortunately many accountants advise their clients improperly in this area. This is a favorite audit target of the EDD. Improper S Corporation distributions can also lead to stiff worker information return penalties that are subject to immediate collection and have no pre-payment due process rights.

    d) S-Corp ONLY: Does the employer offer plans providing for payments to employee's on account of medical or hospitalization expense in connection with sickness or accident disability or death?

    Bob's comment: Another favorite target of the EDD is to access medical insurance and related payments by corporations, especially S corporations, as additional unreported compensation. These assessments also carry stiff worker information return penalties that are subject to immediate collection and have no pre-payment due process rights. These types of expenses, if not included in W2 compensation may be treated as additional S corporation distributions.

  • Have the controlling parties formed any other entities together?

    Bob's comment: This is a potentially dangerous probe by the EDD and can lead to a horizontal multi-entity audit as discussed above.

Conclusion

There are many more questions contained in the EDD Entrance Interview Questionnaire. While some questions appear to be simple and straight-forward, other questions carry great potential harm and risk of assessment. In our next article, we will continue our review of Entrance Interview questions.

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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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