ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – EDD AUDITORS AND EDD COLLECTORS – WHAT’S THE DIFFERENCE? – PART 1
By Robert S. Schriebman
Most governmental taxing agencies, the IRS and EDD included, function in a like manner. That is to say, you can draw an imaginary line down the middle and broadly divide their functions into two main categories: the examination function and the collection function. You can also erect an imaginary wall between the functions. The examination function or division operates separate and independent from the collection function or division.
In this series of articles we will review both the examination and collection functions of the EDD. You will learn what an EDD auditor’s job is all about and you will also learn the job function of the typical EDD collector. Most tax professionals and the public in general are ill informed when it comes to the function and powers of an EDD collector. Their counterpart, an IRS Revenue Officer has huge powers. When an IRS collector is properly doing his/ her job no judge in the land can stop the process.
In this Part 1, I will discuss the role of the typical EDD auditor. In Part 2, I will discuss the role of the EDD Collector.
THE EDD AUDITOR
The EDD is responsible for the determination and collection of four types of taxes.
1. Unemployment Insurance (UI);
2. Disability Insurance (DI);
3. Employment Training Taxes (ETT); and
4. Personal Income Taxes (PIT).
These are the taxes involved when an employer completes and files his or her quarterly and annual tax returns. The auditor’s primary job is to determine the accuracy of the taxpayer’s compliance and to correctly determine the status of workers.
California Underground Economy Project
California has long been both a pioneer and leader in detecting and attacking the underground economy. Industries such as construction, nursing registries, and employment agencies are traditional targets for underground economy investigations. For example, EDD agents together with representatives of the Department of Labor and Workers’ Compensation travel together visiting construction job sites. At these sites contractors and workers alike are interviewed to determine employment violations and improper worker status classifications.
The Audit Process
In addition to the review of filed payroll tax returns, a large part of the work load of an EDD auditor is to conduct an examination of the employer and the employer’s records. The primary objectives of these audits are as follows:
1. To determine if filed returns accurately reflect compensation paid to employees as well as corporate officers and members of LLCs.
2. To determine the proper worker status of individuals receiving 1099s .
3. To determine if W2s and 1099s have properly been issued and to determine if these information returns accurately reflect compensation.
4. To determine if business related expenditures should be reclassified as compensation. Common examples are health insurance payments and credit card expenditures that should have been treated as compensation.
5. To determine if K1 and other distributions to S corporation shareholders should be reclassified as additional compensation.
6. To look for and determine fraudulent conduct on the part of the employers and to also determine if this conduct warrants referrals to city and county prosecutors for criminal prosecution.
There is a maxim I learned as a very young lawyer: Governmental taxing agencies such as the IRS and the EDD, understand and appreciate the role played by a taxpayer’s representative. However, it is one thing to properly and effectively represent your client, but it is an entirely different matter to “piss off” the government. The EDD knows the difference between proper representation and game playing. Some taxpayers and their representatives take the position that an audit is a game of evasion and hiding the ball. This type of conduct helps neither taxpayer nor the taxpayer’s representative. Game playing is to be avoided at all costs! With this in mind let us examine the function of an EDD auditor.
The EDD is an agency of the State of California. As an agency it has broad powers to examine a taxpayer’s books and records and to require the appearance of the taxpayer or third parties. See CUIC § 1127. Of all of the categories set forth above, the most common auditor functions that I have encountered in my practice centers around “status determinations ” i.e., the classification of workers as employees instead of independent contractors. I started representing clients before the EDD in the late 1970s. In my opinion, the auditor’s role in determining worker classifications has changed very little. It has gotten more automated and the demand for transparency has increased, but the tests and objectives of the EDD have basically remained the same.
When it comes to worker classification audits, the EDD tends to be more aggressive than the IRS perhaps due to the absence of a California equivalent to § 530 of the Revenue Act of 1978 which provides a reasonable basis and safe harbor rules at the federal level.
The EDD Auditor’s Search for Documentation and Information
I’m sure you are familiar with that old saying, “If you don’t ask, you don’t get.” EDD auditors tend to ask for quite a bit of documentation and information. Some of it they are entitled to obtain, and some they are not entitled to obtain. Nevertheless, it’s easy to ask for anything. I have several articles on this website that discuss what EDD auditors are legally entitled to request. On the whole, however, I find that the typical EDD auditor pays little attention to categories of documentation and information they are legally entitled to obtain. By way of example, every EDD audit package has a one-page form request for documentation including federal payroll tax returns. EDD auditors routinely ask for federal income tax returns of individuals and corporations. If you want to give the auditor this documentation, that is your decision, but they are not legally entitled to most federal tax returns and information.
In today’s audit climate, the demands made upon CPAs, accountants and tax return preparers, by the IRS are tough and thorough. The IRS demands transparency in the audit process and the accounting profession obliges. While this transparency policy is now commonplace in IRS audits, the same does not hold true for EDD audits. This has caused CPAs and other tax representatives to give the EDD auditor virtually anything and everything requested by the auditor. The unfortunate end result is “TMI – Too Much Information.” This passive attitude has led to huge EDD tax assessments together with penalties.
The EDD Auditor and the Uncooperative Taxpayer
It is essential in the EDD audit process to give the auditor documentation and information necessary to complete the audit, but to do so within the law. This is proper audit representation. Gamesmanship and hiding the ball will get you nothing but trouble. It’s clear that a balance must be reached between the demands of the auditor and what the auditor is legally entitled to obtain and examine. Being unreasonable and failing to cooperate in the audit process, can lead to the following negative results.
1. The auditor can issue a subpoena as well as a demand for documents known as a subpoena duces tecum. Very few of these are issued and are usually issued only in the most aggravated situations.
2. The audit can result in a myriad of penalties including the following: failure to pay; failure to file a return; improper return filed; lack of good cause; negligence; fraud; failure to file annual return.
3. The taxpayer being labeled as “uncooperative.” This does not sit well with administrative law judges.
4. The issuance of an estimated assessment. This type of assessment cannot be settled. Eventually the audit returns to the auditor so it can be done right.
Auditors Are Not Collectors
It is a common misconception that auditors are the ones who levy on taxpayers’ bank accounts, and file tax liens against them. It is also a misconception that auditors are the ones who assess responsible individuals for corporate level assessments. These are the functions of the EDD’s Collection Division – the subject of our next article.
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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