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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – DO EDD AUDITORS MISUSE UNDERGROUND ECONOMY REPORTS?

By Robert S. Schriebman

2020

Introduction

The job of an EDD auditor is to conduct a proper examination of the books and records of a employer and to determine the proper worker status classification of individuals hired by the employer to perform services relating to the employer’s business model. The Employers’ Bill of Rights clearly states that an employer under examination is entitled to an impartial and professionally objective examination. When it comes to the construction industry, EDD auditors are often provided with an Underground Economy Report. I have found however that auditors unfortunately misuse these reports resulting in an unfair and an oppressive assessment that violates both the letter and spirit of the Employers’ Bill of Rights.

This article will discuss the nature of an Underground Economy Report (UER) and how it can be misused by the EDD auditor assigned to audit the general contractor. The results may well be an oppressive assessment not based on reality.

What is an Underground Economy Report?

The UER is a report that is prepared by a joint team of investigators who drive around looking for construction jobsites. They visit these sites unannounced and meet with the onsite contractor or foreman. They also talk to workers. Their job is to find employment abuses, prepare a report, and submit that report to several California agencies. The typical UER team may be composed of an EDD inspector, a Labor Department inspector, a Workers Compensation inspector, and an inspector of the CSLB. They are not concerned about the immigration status of workers.

The inspector’s job is to find non-compliance. Are there unlicensed subcontractors? Do the workers require a CSLB license? Have the workers been reported as employees on payroll tax returns? Are the workers paid in cash? If violations are found, the team prepares an investigation narrative consisting of a Site Inspection Report and an Audit Referral Report.

The Typical Audit Referral Report

The purpose of this report is to provide the EDD with a reason to schedule an audit of the general contractor. Sometimes the report is prepared in order to audit a subcontractor. The typical report discusses what the team observed relating to onsite workers. Sometimes the workers are interviewed but many times these workers are not fluent in English. An English speaking worker is interviewed and the team prepares certain projections relating to all other workers observed on the site. The typical worker interviewed will often state that he considers himself an employee and the number of hours he/she works per week. The team will ask him if he receives a W2 or 1099. If the worker states that he only receives a 1099 or nothing at all, the inspector will prepare a report for a future EDD audit.

Estimated Assessments

In my opinion the most disturbing aspect of the UER is the portion relating to the calculation of an estimated assessment. This is not an actual assessment but merely a projected assessment to be used as a guideline by the EDD and other agencies. Without interviewing most of the workers on site, the inspector will assume that all workers are paid at the minimum wage or higher. The total rate of pay will be calculated at a 40-hour week, without determining how many hours were actually worked. The weekly rate will then be multiplied by a 13-week quarter. Once the quarterly estimated wages are determined, that sum will be multiplied by 12 quarters representing the typical audit period.

I recently reviewed an estimated assessment were there were eight workers on a jobsite. By the time the projection was completed for 12 calendar quarters, the estimated unreported wages totaled over $600,000!

The $600,000 estimated projection was given to the EDD and the employer was contacted for an audit.

EDD Auditor Abuse

In this case, the UER was given to an auditor for the purpose of conducting an examination. The auditor requested the contractor-employer to produce the typical documentation for the years 2016, 2017 and 2018; everything requested was provided by the contractor. The contractor informed the auditor that the company had been dormant since 2011 due to health issues of the contractor. Work was resumed only in 2017. In 2018 the business was closed.

The auditor disregarded all records and the contractor’s statements of business closure. The auditor, for reasons unknown, took the UER and based his assessment on the estimated projections of the UER team. The auditor handed the contractor an assessment based upon $600,000 of alleged unreported wages.

In other words, the auditor “rubber-stamped” the UER findings without giving the contractor the promise of an impartial audit set forth in the Employers’ Bill of Rights. It was easier for the auditor to use the estimations in the UER whole-cloth than to actually take the time to examine the books and records of the contractor. The auditor took the position that the general contractor was dirty – his mind was made up – don’t confuse him with reality. This was clear taxpayer abuse by the auditor.

The Dangers of Going It Alone

I did not represent the general contractor during the examination process. The contractor represented himself and naively believed that he would be treated objectively and fairly in the examination process. It is never a good idea to go it alone in any tax audit. The EDD is especially hard on the construction industry.

Conclusion

Unfortunately I have seen this happen all too frequently, especially when a general contractor-employer does not have competent representation. A responsible representative would have challenged the auditor’s rubber-stamping of the UER without conducting a separate and professional level examination. While there are portions of the UER that may be relevant in an audit, the typical UER does not involve the examination of any books and records. The team is there to report perceived violations of the CUIC and the Labor Code. Projections by the team are often misleading and meaningless. Projections are not based upon facts, they are guesses and when those guesses are adopted whole-cloth by the EDD without an objective underlying audit, you clearly have taxpayer abuse at the highest level.

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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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