ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – EDD CONTRACTOR AUDITS, PART 1 – ESTIMATED ASSESSMENTS WITH NO BASIS IN REALITY
By Robert S. Schriebman
In 2020 the EDD did not conduct audits during most of the year due to the pandemic. Auditors were assigned to assist people with filing unemployment compensation claims. Audits resumed in early 2021. I have seen disturbing audit techniques on the part of EDD auditors especially when it comes to audits of various facets of the construction industry. The purpose of this series of articles is to alert you to these practices as they seem to violate the essence of the Employers’ Bill of Rights entitling an employer to a professional level objective examination. I have witnessed projections and estimations resulting in high assessments from the EDD when these assessments have no basis in fact or reality. This is Part 1 of a 4-part series that will discuss what my contractor clients have experienced in 2021.
The Audit of Sid
The events in the case discussed below are real; they actually happened.
Sid is a licensed drywall subcontractor. He is a small businessman and operates as a sole proprietor. Sid operates solo; he has no workers or helpers. In fact, Sid has not hired a worker of helper since 2016. During the pandemic in 2020, a former worker filed for unemployment benefits falsely stating that he worked for Sid in early 2020 as an independent contractor. In 2020, independent contractors were awarded unemployment benefits. This automatically generated an EDD audit of the employer.
The EDD audited Sid in 2021. The audit involved the years 2017 through the first quarter of 2021. The auditor requested the usual books and records. Admittedly, Sid’s records left something to be desired. All he had were bank statements showing periodic small ATM withdrawals in addition to deposits. All expenditures were for materials and supplies. Sid had no workers; he had no W2s or 1099s. Sid did not file any quarterly or annual payroll tax returns for any period under audit. Because of the false UI claim, the auditor was suspicious of Sid’s operation from the very beginning. The auditor believed that Sid was hiring workers and paying them either in cash or through ATM withdrawals. There was absolutely no concrete proof of any misconduct on Sid’s part.
Acting on a hunch, the auditor added up all of Sid’s gross receipts, month by month, for three full years and arbitrarily allocated 30% of gross receipts as worker compensation. Taxes, harsh penalties and interest were assessed against Sid. The penalties included: a 15% negligence penalty, and two stiff worker information return penalties amounting to close to 13% of “compensation.” The auditor gave Sid a bill for $75,000 going back to the year 2017. This assessment was against Sid personally as a sole proprietor. It had potential devastating economic consequences.
The auditor had no concrete evidence that Sid actually hired anyone in any period under audit. The auditor had a bias against Sid and suspected wrong-doing without any evidence whatsoever.
The Problem with the Quality of this Audit
Violation of the Employers’ Bill of Rights
EDD Publication DE 195 explains the Employers’ Bill of Rights. With regard to the quality of an EDD audit it states, “You have the right to an impartial audit and a full explanation of the audit findings.” An employer is entitled to a professional level, objective audit conducted by an experienced auditor. There is no place for bias or creating an assessment out of a hunch on the part of the EDD.
An auditor is allowed to shift and allocate actual payments to workers, but cannot create compensation out of whole cloth!
The assessment against Sid was based solely on estimations and projections. The Notice of Assessment stated that the assessment was “estimated.” An estimated assessment is a special animal because it cannot be settled administratively through the EDD’s Settlement Unit. It must be taken before a judge of the CUIAB. This is a costly and time-consuming undertaking.
What To Do First?
The first thing that must be done upon receipt of a Notice of Assessment is to file a petition with the CUIAB. This protects your rights to challenge the assessment administratively and avoids your having to pay the assessment before it can be challenged. Failure to timely file a petition means that the proposed assessment becomes final and subject to collection. It’s a shame how many calls I get from employers as well as accountants and attorneys who never bothered to file a petition and now do not understand how they came to owe so much money. Filing a timely petition is the first thing you must do! There are many articles on this website that instruct you on what to do when you receive a Notice of Assessment.
After a petition is filed, the quality of the audit must be challenged by directing confronting the assigned auditor and challenging the auditor to produce the reasonable basis for the assessment. If the auditor is nonresponsive, or the explanation not satisfactory, it is imperative that the agent’s immediate supervisor be brought in. Many supervisors are reluctant to overturn an assessment or overrule the auditor. If you do not get satisfactory results from the supervisor, your next step is to meet and confer with the audit office manager. Sometimes a judge hearing is necessary in order to confront the poor quality of the audit.
A Conundrum for your Income Taxes
If you challenge an EDD assessment before the CUIAB, it could take months, even years, before your case comes up for a hearing. If the EDD reclassifies draws and other income sources as worker compensation, should you file amended IRS and FTB income tax returns deducting the reclassified amounts as an ordinary and necessary business expense – wages? Is this filing false income tax returns? If you win your case before the CUIAB, and there are no additional wages, you have to again amend those tax returns. Because you are amending several returns, as the EDD audit has involved several years, do you have exposure to an IRS audit involving worker status issues? If you lose your case before the CUIAB, or settle it on the courthouse steps, some part of the assessment confirms that there was additional compensation. This creates a real conundrum with no clear direction.
A case like Sid’s has an element of unfairness to it because it requires a person in Sid’s position to prove a negative – that he did not have employees and did not pay compensation. Sid’s problem was solved by his creating and submitting to the EDD a sworn declaration under penalty of perjury that he did not have any workers during any audit period.
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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