Ask The California Employment Tax And Payroll Tax Attorney – EDD And The Construction Industry – Moving Targets
By Robert S. Schriebman
EDD audits of all types of construction contractors are special challenges for both the contractor and the professional representative. The EDD as an institution seems to take a special interest in contractors generally, and views them, in my opinion, as moving targets for high assessments and multiple penalties.
EDD audits of contractors can be tough going. Most auditors have made up their minds in advance of receiving any documentation or information. They take the position that all workers and service providers of general contractors should be reclassified as common law wage earners. There are no allowances made for such things as material, supply and tool reimbursements. The gross amounts stated on 1099s are deemed totally taxable wages generating maximum assessments. Settlement negotiations are challenging and often settlement proposals from the EDD’s end have become stingy since the enactment of the ABC Test.
EDD audits of contractors primarily focus around worker status. This article will discuss long-standing EDD subcontractor-worker status and will also look at changes brought about by AB5 and AB2257. I will also discuss Labor Code § 2781 and its impact upon the construction trucking services.
Worker Status Relationships Under the Old Rules
The old rules are found under Sections 621.5 and 13004.5 of the CUIC, and Labor Code § 2750.5. When an EDD auditor seeks to reclassify subcontractors and workers treated by the general contractor as independent contractors (ICs), the auditor most likely will conclude that these workers should never have been treated as ICs and must be reclassified as W2 wage earners with all the applicable taxes, penalties and interest. Under these code sections, all of the following criteria must be satisfied if the worker is going to be treated as an IC:
- The worker has the right to control the manner in which services are performed.
- The worker is customarily in an independently established business.
- The worker’s independent contractor status is bona fide and not a subterfuge to avoid employment status.
- The worker holds a valid contractor’s license for the type of service performed.
Assuming, for the sake of this discussion, that the general contractor meets all of the above criteria, will the contractor receive a “get out of jail free card?” Not so fast; the EDD will not stop here. A contractor will now be subject to a second hurdle under AB5 and AB2257, the so-called ABC Test.
The ABC Test
In a nutshell the ABC Test can be explained as follows:
A worker may be treated as an independent contractor when all of the ABC Test is met.
- The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
- The person performs work that is outside the usual course of the hiring entity’s business.
- The person is customarily engaged in an independently established trade, occupation, or business or the same nature as that involved in the work performed.
The ABC Test has been used by the EDD for about one year. From what I have seen it is a rare day when an auditor will conclude that the employer, especial a contractor, has satisfied all 3 elements and is given another “get out of free card.”
Assuming for the sake of this discussion, that the contractor passes the ABC Test, is the contractor now free of any potential EDD assessment? Again, the answer is no. The contractor must now jump through the third hurdle: compliance with the Borello standard.
The Borello Standard
The primary factor in Borello, as it is in most EDD auditor analysis, is the right to control and the objective manifestation of control. Borello, 48 Cal. 3d at 350-351. The Borello Court identified several ‘secondary factors’ that must also be considered. These secondary factors include:
- whether the worker is engaged in a distinct occupation or business
- the kind of occupation, with reference to whether the work is usually done under the direction of the principal of time over which the services are to be performed;
- the skill required in the occupation;
- whether the principal or the worker supplies the instrumentalities, tools, and place of work;
- the length;
- the method of payment, whether by the time or by the job;
- whether the work is part of the regular business of the principal or by a specialist without supervision, in the locality;
- whether the principal has the right to discharge at will, without cause; and
- whether the parties believe they are creating an employment relationship.
Labor Code § 2781
This section is applicable to construction trucking services. A CSLB license is not required, but the subcontractor must meet the conditions below:
- The subcontractor must be in business. This means doing business as a sole proprietorship, corporation, LLC or LLP. The subcontractor has a separate business location. The subcontractor holds himself out to the public to be in business for him/herself.
- The subcontractor must be registered with the Department of Industrial Relations.
- The subcontractor must hold a valid motor carrier permit issued by the DMV.
- The subcontractor negotiates with and is compensated by a licensed contractor.
- The subcontractor hires and fires its own workers.
- The subcontractor has errors and omissions insurance.
Assuming all of the above labor code conditions are met, the trucking company must pass the Borello standards.
In addition to jumping over all of the hurdles relating to worker status, EDD auditors often overlook such allowances as materials, tools and supplies that may be buried in the 1099 issued to the service provider. In addition, the EDD consistently fails to apply the “small job rule.” This rule does not require the issuance of an 1099 for occasional workers receiving $500 or less.
It seems that no matter which way the general contractor turns, or what tests is passed, the very next hurdle is designed to snare the contractor and reclassify service providers as common law wage earners. Does this mean all doors for IC status are closed? Does this mean that any and all EDD audits are lost from the get-go? At the audit level this seems to be the case. The best approach is to complete the audit and obtain the best possible out-of-court settlement.
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 50 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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