Ask The California Employment Tax And Payroll Tax Attorney – EDD Audits – What You Need To Know – Part 1

By Robert S. Schriebman
2023

 Introduction

This is Part 1 of a 2-Part series that will discuss basic information about an EDD audit. In Part 1, I will discuss the audit process, the Entrance Interview, the periods covered by the audit, and the scope of the audit. Part 2 will discuss providing business records for the audit and what the EDD is legally entitled to receive.

Officially the EDD will inform the employer that the purpose of the audit is educational outreach and protection of the worker to ensure benefit coverage. Those are indeed noble words. My experience of several decades representing clients under audit is substantially different. To me and my clients it’s all about issuing assessments and increasing the size of the California Treasury.

Why Are You Being Audited?

There are many reasons why an employer is selected for audit. The most popular reason stems from a former worker who was treated by the employer as an independent contractor requesting unemployment benefits (UI) and receiving them. During COVID workers who were improperly treated as independent contractors received UI benefits. This provided audit leads that are still active audits today. These types of scenarios are music to the EDD’s ears. By far, more clients have given me feedback on what auditors have told them triggered the examination. Employers who contest a former contractor’s application for UI benefits are also targets for an audit.  Another popular reason involves the employer who issued a disproportionately large amount of 1099s for the size of the business. Finally, an informant may have tipped off the EDD that he/she was being paid in cash or being paid under the table. In this type of situation, the employer may have given the worker an understated W2 or 1099.

The Entrance Interview

The Entrance Interview is a process whereby the EDD attempts to obtain as much information and documentation as possible. During the COVID crisis the EDD conducted these interviews remotely over the phone. In this post-COVID era the EDD is now wanting to do face-to-face-on-the-premises interviews. There is much psychology involved in this process. The EDD wants to appear friendly and benign. The employer wants to put forth the best image possible and will try to convince an auditor of sound business practices and no improper conduct. The Entrance Interview can be a potential trap for the unwary. A smart employer will first engage the services of an experienced tax professional who will act as a go-between a keep the employer far away from the auditor.

Periods Covered by the Audit

The standard audit period is 12 payroll tax quarters or 3 calendar years. However, this only applies to employers who have registered with the EDD, issued W2s, and have filed EDD payroll tax returns. For those employers, who are not in this pattern of compliance, the auditor has a right to go back as far as 8 years! This means that an employer who has not registered with the EDD and has issued mostly 1099s without filing quarterly EDD payroll tax returns clearly has this 8-year exposure. In the last couple of years, I have seen a dramatic increase in extended audit examination periods.

The Scope of the Audit

The auditor will review business ownership, the type of entity, and whether workers receiving 1099s were, in reality, W2 wage earners. Now that there is the ABC Test, it will be much easier for auditors to find workers who have been misclassified as independent contractors. The auditor will review 1099s and W2s against general ledgers and check registers to make sure they reconcile. Auditors will often select a representative sample of 1099 recipients and conduct interviews to determine if they were misclassified. This is especially true in the construction industry, including those employers engaged in landscaping.

With the ABC Test now the law of the land, employers can expect large assessments together with several penalties such as the negligence penalty and very stiff worker information return penalties.

Information Sharing With the IRS

There are long-standing exchange agreements between the EDD, FTB, and the IRS. The IRS is primarily interested in reviewing assessments which have become final and are not being contested by employers who have filed petitions challenging the assessments.

Conclusion

In Part 2, I will discuss providing business records for the audit and what the EDD is legally entitled to receive.

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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.

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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