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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – EDD AUDITS IN 2025– WHAT YOU NEED TO KNOW – PART 1

By Robert S. Schriebman

2024

Introduction

This is Part 1 of a 2 Part series. The Employment Development Department (EDD) is often referred to as the “unknown tax agency.” We are all familiar with the Franchise Tax Board and the Sales and Use Tax Agency. Most of us come into contact with the EDD when we find ourselves out of a job. We apply to the EDD for Unemployment Benefits. Indeed, most of the work done by the EDD, from the COVID outbreak onward, has concerned itself with providing unemployment benefits and going after those who have received benefits while working under cover. These are known as overpayments.

EDD also has a very important function. It conducts audits of employers who improperly treat their workers as independent contractors or who pay workers in cash and file fraudulent payroll tax returns and issue inaccurate W2s or 1099s. This article will focus upon worker status audits. The laws involving these audits are found in California Unemployment Insurance Code (CUIC).

In this Part 1, I will discuss the following:

Initial contact from the EDD
Periods covered by the audit
Scope of the audit
Business records required for the audit
How the EDD works with the IRS

Initial Contact from the EDD

You know you are being audited by the EDD when you receive a package containing the following documents:

Inquiry Regarding Records
Pre-Audit Questionnaire
Documentation Required for the Audit

You are given 14 days to complete the Pre-Audit Questionnaire and provide required records. The 14-day period may be extended if you are seeking professional representation, or you need more time. You must contact the assigned auditor to request more time.

Many employers under audit panic at the 14-day deadline. The EDD does not enforce this deadline and you will not be penalized if you take additional time to respond and provide documentation.

Periods Covered by the Audit

Generally, the audit covers a 3-year period or 12 calendar quarters. The statute of limitations for examination is found in § 1132 of the CUIC. This is the basic audit period. The audit period may be extended to 8 years if the employer does not have a history of filing quarterly and annual payroll tax returns. It is common in the construction industry for the audit to be expanded beyond the basic audit period. If you believe you have exposure to the 8-year expanded audit period, you should contact professional representation before responding to the EDD audit notice.

Scope of the Audit

The auditor will initially determine whether you have adequate books and records. If your records are not up to snuff, the auditor may issue several penalties in addition to the basic assessment. The auditor will test the records for one year to determine if the audit period should be expanded to the basic 3-year period or beyond. The auditor will then determine if there are “questionable items.” This is EDD code for discovering independent contractors should have been treated as W2 wage earners.

During this process the auditor most likely will have many questions to ask you. Remember, the auditor is not your friend. He or she may appear quite friendly and even address you by your first name. BEWARE – the auditor’s primary goal is to issue you an assessment. The basic assessment consists of the following taxes:

Unemployment Insurance Tax
Disability Income Tax
Employment Training Tax
Personal Income Tax

BUT WAIT – In addition to the above 4 taxes, EDD auditors love to assess penalties. Among the most popular penalties are the negligence penalty, failure to file penalty and 2 worker information return penalties. The penalties, standing alone, may exceed in amount the above tax portions.

The auditor is required to verify that your acknowledged gross wages and taxable wages have been properly reported. The auditor will also test 1099s by verifying the amounts with the general ledgers or other original books of entry.

In addition to these penalties, there are two fraud penalties.

Business Records Required for the Audit

This is the dicey area of the audit. When you initially receive the audit notice, you will receive a long list of records that the EDD demands be produced. A naïve or inexperienced employer or CPA will not take the time to determine if the EDD has a legal right to demand the listed documentation. The list is nothing more than a fishing expedition. Blindly providing the EDD with everything on its list will not do you any service and has the potential to result in larger than usual assessments and penalties. Here is where you need professional representation. A knowledgeable practitioner will provide the EDD the bear legal minimum. Professional advice protects the employer and results in a fair and relevant audit.

How the EDD Works with the IRS

The EDD shares audit information and makes it available to the IRS. An IRS audit with a resulting assessment is several times larger than its EDD counterpart. Not all employer audit information is given to the IRS. Timing is everything and many audits can be resolved without IRS involvement. This is where professional representation may pay big dividends.

Conclusion

In Part 2, I will discuss the EDD’s demand for specific “required records,” and how the minimum demand may be expanded. I will also discuss the auditor’s exit interview, the CUIAB and the settlement process.

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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 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 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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