Ask The California Employment Tax And Payroll Tax Attorney – EDD Audits – What You Need To Know – Part 2

By Robert S. Schriebman
2023

Introduction

This is Part 2 of a 2-Part series that will discuss basic information about an EDD audit. In Part 1, I discussed 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.

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.

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.

EDD’s Demand for Books and Records

The EDD publishes an Information Sheet about the audit process. There is a section that informs the employer to review an attached list of documentation and information required for the audit. Many of the items requested are totally appropriate and relevant, but there are many items on the list that the EDD has no right to request, or these records are either irrelevant or too burdensome for the employer to produce. For example, general ledgers and general journals are always requested, but only portions of this documentation are relevant for the audit. Certainly, those portions that show payments to W2 wage earners and 1099 service providers are appropriate and relevant, but portions related to ordinary business expenses such as rent, utilities, advertising, etc. have no place in an EDD audit. IRS employment tax returns, such as 941s and 940s are not relevant and need not be provided. These are federal documents that play no part in an EDD audit.

The EDD loves to go on “fishing expeditions” through the employer’s books and records to find anything and everything they deem to be unreported compensation. For example, credit card statements are just the ticket for an EDD fishing trip.

Preparing Schedules and Spreadsheets for the Auditor

Most experienced EDD auditors know that the employer is not expected to do their homework. This means that the employer is not legally obligated to prepare presentations such as schedules and spreadsheets. However, the EDD is always hiring new auditors because of turnovers and retirements within the audit office. New and inexperienced EDD auditors will demand that the employer make their jobs easier by scheduling out lists of service providers and preparing spreadsheets that did not exist prior to the audit. Here are a few tips:

• The employer is not required to prepare schedules and/or spreadsheets that did not exist before the audit began.
• The employer cannot give the EDD auditor that which the employer does not have.
• The employer is not required to furnish documentation or information already in possession of the EDD, just because it is inconvenient for the auditor to retrieve it internally.

Conclusion

A wise and careful employer will seek the advice of an experienced EDD audit professional before surrendering any documentation to the EDD.

I have been representing employers in EDD audits for several decades and I can tell you that no two audits are the same. There is always a tension between what the auditor feels he/she is entitled to receive and the appropriate furnishing of relevant documentation for the audit process. Whenever I challenge an auditor to justify why their demand for documentation is relevant, without fail, the auditor will tell me that they have a right to the documentation, etc., because it says so on their list (Form DE 231TA). This response on the part of the auditor has no bearing to what the auditor is legally entitled to review.

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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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