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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – NAVIGATING YOUR WAY THROUGH ALL THOSE EDD PENALTIES – PART 1

By Robert S. Schriebman

2019

Introduction

This is Part 1 of a 2-Part series that will discuss the most common EDD penalties assessed during an EDD audit.

Employers audited by the EDD are likely to receive penalty assessments along with the usually assessments for the basic payroll taxes: UI, DI, ETT, and PIT. It is rare to receive an audit assessment with no penalties, just taxes and interest. Why does the EDD assess penalties? The usual answer is that the auditor honestly believes the tax violations warrant them. I submit that there may also be hidden agendas for their assessment. For example, penalties may be assessed only to be bargained away by the auditor in reaching a "deal" with the taxpayer-employer, or his/her representative. The auditor concedes the penalties if the employer concedes the tax assessment. Penalties may also be assessed only to be negotiated away through dealings with the EDD's Settlement Unit. Having said this, I am encountering EDD settlement officials who are insisting on assessing some penalties as part of the settlement. This position should be vigorously opposed!

When an EDD audit is completed, the auditor prepares an Audit Report (AR). A portion of the AR has a section devoted to the assessment of penalties and the explanation by the auditor of why the specific penalty was assessed. The penalty section is a very important part of the AR and should not be ignored. You are entitled to receive a copy of the AR, but you must ask for it; it is rarely given voluntarily.

How Many Penalties Are There?

The EDD has a lot of penalties in its inventory; 27 all told. Out of the 27 only 17 are commonly assessed and those 17 will be discussed in this series of articles. Most ARs list no more than 14 penalties, but that is still a lot of penalties!

How Are Penalties Removed?

The process of removing an assessed penalty is known as "Abatement." Many EDD penalties, in the EDD's inventory, can be abated for "good cause," one penalty can be abated for "reasonable cause," and some penalties have no grounds for abatement at all. There is no definition in the body of EDD law that defines "good cause." The only references are portions of Title 22 Regulations that state that good cause depends upon the facts and circumstances. To me there is no material distinction between good cause and reasonable cause. There are standards for reasonable cause.

The best places to find a definition of reasonable cause are the Internal Revenue Manual (Chapter 20), and the US Supreme Court Boyle decision (Boyle v. U.S., 469 US 241 (1985). Boyle held that reasonable cause is defined as ordinary business care that a prudent business person would use in the conduct of his/her day-to-day business affairs. It does not require super-human effort or intelligence.

Let's Look At Those EDD Penalties

In this discussion I will set forth the specific code section of the California Unemployment Insurance Code (CUIC). I will state a brief overview of the penalty, its amount, and the grounds for abatement.

CUIC § 977(c): This penalty is known as "SUTA dumping" penalty. This penalty concerns the assessment of the UI tax. When a business is first created and obtains an EDD account number it pays the lowest UI rate on the rate schedule. After a few years, the UI is increased to the maximum rate based upon UI claims filed. Unfortunately, there are employers who will create a new entity when the rate gets too high and try to fool the EDD into giving them a new lower rate for the new company. This is known as "SUTA dumping." The penalty is the assessment of the maximum UI rate plus 2% for the applicable rating periods.

Abatement: There are no grounds for the abatement of this penalty. However, you can certainly argue the valid business reasons for creating the new entity

CUIC § 1088.8(e): This penalty is asserted for the failure to report an independent contractor as required and within the time set forth in CUIC § 1088.8(c). I have not seen this specific penalty assessed but I believe it is a sleeping giant ready to be activated. The penalty is $24 for each failure to report an independent contractor or $400 if the auditor determines that the employer and the contractor together conspired to avoid the law.

Abatement: Good cause. You have the burden to show there was no conspiracy.

CUIC § 1112(a): This is a common penalty assessed in many audits where the employer failed to file quarterly returns. The penalty is asserted for failure to timely pay employment taxes. This is a 15% penalty on the gross amount of the tax deficiency.

Abatement: Good cause: If the employer has a reasonably arguable position for treating the worker as an independent contractor, this should be sufficient good cause.

CUIC § 1112(b): This penalty is assessed for the failure to remit quarterly payments electronically. Nowadays, the EDD wants payments made electronically through its website. This is a 15% penalty on the gross amount of the tax deficiency.

Abatement: Good cause: If the employer has a reasonably arguable position for treating the worker as an independent contractor, this should be sufficient good cause.

CUIC § 1112.1(a): This is a penalty for the failure to file quarterly and annual payroll tax returns electronically. This penalty is in addition to all other possible penalties imposed by the CUIC. This penalty is $50 per return.

Abatement: Good cause: If the employer has a reasonably arguable position for treating the worker as an independent contractor, this should be sufficient good cause.

CUIC § 1112.5(a): This penalty is imposed for the failure to file quarterly and annual returns within 60 days of their respected due date. The penalty is imposed only on amounts that were not paid prior to the filing deadline. This is a common penalty assessed by EDD auditors. It is assessed in addition to the penalties imposed under CUIC §§ 1112, 1126 and 1127 that will be discussed below. This penalty is 15% and is imposed on the late contributions including the UI, DI, ETT and also the PIT portions of the assessment. It is easy for EDD auditors to impose this penalty along with the traditional penalties that are imposed when the employer treats all workers as independent contractors and does not file payroll tax returns.

Abatement: Good cause

CUIC § 1114(a): This is known as the Wage Item Penalty. It is common on many audit assessments. This is a $20 payment per violation for the failure to file wage reports within 15 days of a specific written demand.

Abatement: Good cause: While this penalty is commonly assessed by EDD auditors, there is no moment in time during the audit process where the auditor issues a written demand for the filing of any payroll tax returns. I believe this is a fatal flaw in the assessment of this penalty.

CUIC § 1117: This is known as the Annual Return Penalty. This is a stiff penalty of the lesser of $1,000 or 5% of the employer contributions determined by the auditor. The Annual Reconciliation Return must be filed within 30 days of written notice by the EDD.

Abatement: Good cause: While this penalty is commonly assessed by EDD auditors, there is no moment in time during the audit process where the auditor issues a written demand for the filing of any Annual Reconciliation Return. I believe this is a fatal flaw in the assessment of this penalty. There are between 3 and 4 annual filing periods in most common EDD audits. So this penalty is rather substantial and should be fought.

Conclusion

This concludes Part 1 of a 2-Part series giving you an overview of the most common EDD penalties assessed during the audit process. In Part 2 we will review more penalties including the Negligence Penalty, and the two fraud penalties.

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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. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.

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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