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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WHAT IS A “NO-CHANGE” AUDIT AND HOW CAN YOU GET ONE?

By Robert S. Schriebman
2019

Introduction

The best news you will ever hear from an EDD auditor are the words, "No-Change." This means that there will be no assessment as result of your EDD audit. These words also mean that you can maintain the status quo and operate according to you current business model. While there are no assurances that you will not be audited by the EDD in the future, the chance of the EDD reopening your matter for a second look down-the-line is remote. This article will briefly discuss several ways that you can get to "no-change."

You Have No Independent Contractors And You Do Not Issue 1099s

Perhaps the most efficient way to avoid an audit and to arrive at "no-change" is to prove that you do not engage outside independent contractors. This does not mean that the EDD will simply close your file. You will have to prove a negative and that can be difficult. The auditor will ask you to produce copies of your general ledgers and other third party payment records. Most all businesses do issue some 1099s for professional services such as a CPA or an attorney. Some companies issue 1099s to landlords for the payment of rent. Once you prove that your 1099s are limited, you should be in the clear.

Keep in mind that EDD auditors not only look for payments to third parties, but they also test payroll to make certain that the W2s jibe with your books of original entry. These worker payments may also be tested against amounts shown on filed EDD payroll tax returns.

You Do Hire Independent Contractors But They All Work Out of California

As part of every EDD audit, you will be asked to produce copies of issued 1099s for up to four years. When furnishing the EDD auditor these 1099s it is important to point out every recipient located outside of California. If the services are not performed in California, payments to these 1099 recipients cannot enter the audit equation. In other words, these payments don't' count.

I make a practice of taking a RED Sharpie and mark each and every 1099 representing services performed outside California. Don't just tell the auditor that Sam Jones works in Nevada. You need to make a bold statement on each 1099. That's what the Sharpie is for. The same applies to W2 workers located outside of California.

1099 Workers Exempt By Statute

Certain classes of workers who are 1099 recipients are exempt by law from being reclassified as W2 wage earners. These workers include medical doctors working in hospital emergency facilities, licensed real estate agents working directly under a licensed broker, and certain outside commissioned sales persons. This list is not exclusive. Having said this you may encounter an EDD auditor who is unfamiliar with these statutory exemptions. If this is the case, you must be proactive. Contact the auditor's immediate supervisor and if necessary speak with the overall Manager of the Area Audit Office (AAO).

Getting a "No Change" The Hard Way - Paper, Paper, Paper

As a retired adjunct professor at USC teaching tax practice and procedure, I have always stressed with my students the importance of providing the government with sufficient written documentation to prove your case or point. Even though we live in an era of computers and virtual reality, these old lessons are still valid. I recently completed an EDD audit for a client in the sports industry. He retains professional advisors to assist professional athletes. In order to prove that each advisor was an independent contractor I had my client prepare individual folders each containing the professional's credentials, as well as photographic documentation showing the services performed by each of them. I sent all the folders to the EDD auditor. The EDD auditor had no choice and nowhere to turn except to grant my client a "no-change." If you are going to follow this advice, make sure that you do not send the EDD any original documentation that you cannot replace - copies only.

Conclusion

EDD "no-change" audits are difficult to get, very few are issued. No one receives a "no-change" unless he/she is proactive. Do your homework and prepare the appropriate presentation to convince the auditor that you are correct. Some occupations are exempt by statute, but most require the right kind of paperwork to drive home your argument.

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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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