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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WHY DOES THE EDD TARGET GENERAL CONSTRUCTION CONTRACTORS - PART 2?

By Robert S. Schriebman

2019

Introduction

This is Part 2 of a 2-Part series that will discuss EDD audits of general construction contractors from a representative's point of view.

Why does the EDD target general construction contractors? The short answer is that audits of general construction contractors yield big bucks for the California State Treasury. Audits of general construction contractors usually yield profits to the EDD per audit-hours worked; a positive return on the investment of time. I cannot remember when an audit of a general construction contractor resulted in a no change. I find that they can be punitive and unfair.

Every taxpayer, under audit by the EDD is entitled to a series of rights that are set forth in the EDD's Employers' Bill of Rights discussed below.

EDD's Employers' Bill of Rights

If you are a general construction contractor under audit by the EDD you should ask your assigned auditor for a copy of the Employers' Bill of Rights (EDD Publication DE 195). There is not a lot of information in the brochure handout relating to audits per se. Most of the topics deal with collection issues, penalty abatement, and appeal rights. However, there is one very important heading entitled, "An Impartial Audit." The key provision is as follows: "You have a right to an impartial audit and a full explanation of the audit findings." Sadly, I find the general construction contractors rarely experience an impartial audit. The brochure handout is never given in the basic audit package notifying the employer that he/she is under examination. You have to ask for it.

In this part 2, I will give you a few real world examples of how the EDD fails to give a general construction contractor a professional and objective audit. These examples are by no means exclusive, but they are common in most of the construction industry audits that cross my desk.

Examples of EDD Sloppy Audit Practices That Hurt Your Wallet

I have taken these examples of sloppy EDD audit practices from several recent audits of general construction contractors.

  • Ignoring the "small jobs" rule: Most contractors know about this rule. A worker who receives $500 or under per job does not require a CSLB contractor license. Too many audits honor not discuss this rule. It usually comes up when a worker interviewed by the EDD auditor reminds the auditor that he/she does not need a license because the amount received was below the threshold.
  • Categorizing laborers as unlicensed subcontractors: In a recent audit I discovered that the auditor penalized the contractor for hiring unlicensed subcontractors who were only unskilled laborers. The auditor did not take the time to define the work performed by these workers other than to designate them as "helpers." Laborers who simply provide supporting help and do not actually do framing, painting, or dry-walling are not contractors and they do not require a license.
  • Refusing to make allowances for materials, supplies, and the rental of equipment: Most EDD auditors simply look at the gross amount stated on the 1099, or the payout entry in the check register or general ledger, and never bother to ask the contractor if any of the payments represent reimbursements for materials, supplies or the rental of equipment. When confronted with this failure, the auditor will require the production of specific invoices breaking down payments for services vs. reimbursements.
    There is a very important lesson here to be learned: Obtain invoices from subcontractors setting forth charges for materials, supplies, and reimbursements. Historically, the EDD may allow a minimum of 30% of the invoice for these reimbursements especially when it comes to obvious expenses for tile, flooring, paint, etc.; there should also be reimbursements allowed for tool replacement. The way things stand currently - no invoice - no reimbursement allowance.
  • Unrealistic projections: One of the worst audit abuses I have seen recently was an unrealistic projection based upon payments made to 3 laborers - here's the story. My client engaged 3 laborers. One laborer worked for 3 months, another for 9 months, and the other for several years. One laborer was paid $500 per week. The other two were paid per day at $160 and $100, respectively. The workers did not receive either W2s or 1099s. This caused the auditor to estimate how much the employer-contractor failed to report over a three-year basic audit period. The auditor estimated that their average weekly compensation was $600. He then multiplied this figure by 13 weeks, which represents one calendar quarter. The quarterly estimate totaled $23,400. The auditor then multiplied this figure by 12 quarters making up a standard three-year audit. The auditor concluded that the employer failed to report $346,962 in unreported 1099 compensation. The auditor then assessed payroll taxes, several penalties and interest. There was absolutely no basis in fact for this projection.
  • Assessment of stiff penalties: If you have read my articles you know that the EDD has an inventory of 14 different penalties that it can assess a general construction contractor. The most common penalties will be as follows:
    • - The Negligence Penalty - CUIC § 1127, this is a 15% penalty
    • - First level Worker Information Return Penalty - CUIC § 13052, this is $50 per violation per year
    • - Second Level Worker Information Return Penalty - CUIC § 13052.5, this is 12.3% of payments made to unlicensed subcontractors or employees not receiving W2s or incorrect W2s.
  • The auditors' failure to give the contractor under audit information and documentation to remove or reduce the Personal Income Tax (PIT) portion of the assessment: anyone under audit may have the opportunity to persuade the auditor to remove one of the largest portions of the assessment. Therefore, you wind up paying more taxes, penalties and interest than you should.

Conclusion

In this Part 2 I discussed specific examples of how EDD auditors conduct examinations of construction industry employers and how these examinations are sloppy and are always tilted against the contractor with punitive penalties to boot. There is no magic formula that will guarantee that a general construction contractor will receive a professional level objective examination by the EDD. If you are not getting this level of professionalism from your EDD auditor you should be proactive and demand a conference with the auditor's supervisor and even the manager of the EDD Audit Office. Too many people under audit suffer in silence, and that's just not right!

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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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