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How to handle an EDD Audit Part 1 - Spidell's California Taxletter (May 2009)

HOW TO HANDLE AN EDD AUDIT

By Robert S. Schriebman

PART 1

This article will discuss a practical basic approach to effectively representing your client before the California Employment Development Department, better known as the EDD. The EDD is California's third largest taxing agency. The EDD has the responsibility of administering the collection, accounting and enforcement functions of four basic employment taxes: the unemployment insurance tax (UI), the employment training tax (ETT), the disability insurance tax (DI), and the personal income tax (PIT). When the EDD audits your client, all 4 of these taxes will be in issue.

The EDD also has a fraud division. This division is involved in aggravated cases of misclassification of workers as independent contractors. Most of your audit experience with the EDD will be involved in what as known as "status audits". This is a technical term for an audit that involves misclassification of workers as independent contractors. The EDD tends to be more aggressive than the IRS due to the absence of a California equivalent to Section 530 of the Revenue Act of 1978 which provides reasonable basis and safe harbor rules for treating workers as independent contractors.

There is increasing cooperation between the EDD and the IRS when it comes to status audits. Most of the time the IRS will not consider and review the results of an EDD audit unless and until EDD examination of a targeted employer is completed. The IRS may conduct a full scale examination on its own or take the work papers of the EDD and base its assessment upon EDD findings. I have found lately that the IRS has taken the results of an EDD audit on an S corporation and has assessed the equivalent of self employment taxes against its shareholders based upon complex formulas and statistics. When handling an EDD audit, you as the representative must always keep in mind, and advise your client, of the possibility of future IRS involvement.

The functions and powers of the EDD are set forth in the California Unemployment Insurance Code, which I will be referring to as "CUIC". The EDD has broad powers to examine a taxpayer's books and records and to require the appearance of the taxpayer or third parties (CUIC 1127).

FIRST THINGS FIRST - HOW THE AUDIT BEGINS

This is our hypothetical case: Your corporate client, a general drywall contractor, hires individuals that it treats as independent contractors. A few of these individuals have there own current contractors license, but the vast majority of workers, while skilled, have no license of any type. Due to our current economic slow-down, our client is forced to let a few of these unlicensed workers go. One of the unemployed workers goes down to his local EDD office, files for unemployment benefits as an employee, and gets those benefits. He informs the EDD how your client does business. That is all the EDD needs to assign an auditor to audit your client.

The auditor will send a package to your client. The package will consist of an audit notice, a pre-audit questionnaire and a pre-printed standardized request for records covering a specific audit. The auditor may also send your client a request to extend the statue of limitations. The first thing that you must do is to have your client send to you any and all correspondence that the EDD sends to your client. You must also inform your client never to assume that you have been copied on any EDD correspondence. Even after the EDD receives your Power of Attorney, they do not do business like the IRS where client correspondence is automatically copied to the holder of the Power of Attorney. This is true even when the audit is completed and the EDD issues a Notice of Assessment. They will send the Notice of Assessment to your client without copying you, the representative.

The next step is for you to complete and have your client sign the proper EDD Power of Attorney (Form DE48). You can obtain this form on the EDD's website. Do not use a Power of Attorney from the IRS or any other California taxing agency such as the FTB. After the Power of Attorney is properly completed and executed send it to the assigned auditor followed by a telephone call introducing you as the taxpayer's representative.

In the next installment we will discuss how to properly respond to the EDD's demand for books and records and issues relating to the extension of the statue of limitations for examination. We will also examine issues relating to the legal status of your corporate client to do business with the EDD auditor.