Ask The California Employment Tax And Payroll Tax Attorney – EDD Contractor Audits, Part 3 – When The Auditor Takes An Inadequate Sampling

 By Robert S. Schriebman
2021

Introduction

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. Part of an objective examination is the responsibility of the auditor to take a proper representative sampling of workers and their functions before considering reclassifying an entire group of workers as employees rather than independent contractors. If an inadequate sampling is conducted, it is improper to reclassify any group of workers as employees. This is Part 3 of a 4-part series that will discuss what my contractor clients have experienced in 2021.

The events described in the case below are real; they actually happened.

The Case of George’s Corporation

George is a licensed general contractor and has been in business since 2015. He does business as an S Corporation. The corporation uses the services of only licensed subcontractors, but also hires workers and day laborers who are not licensed. Since 2018 George and his corporation hired about 90 such workers and day laborers. Some had been with George continuously since 2018, but most are short-termed workers many of whom earn less than $500 per year. All licensed subcontractors have received each year 1099s, but very few workers and day laborers received 1099s. The workers did not receive W2s.

The assigned EDD auditor has taken the position that all workers and day laborers should have received W2s as employees. In order to justify the auditor’s position, the auditor decided to take a representative sampling of the workers. George provided a list of 30 workers, names and contact information. The auditor sent out ten postcards to the names and addresses provided by George. Out of the ten attempted contacts, only 4 workers responded. The auditor conducted telephone interviews of each of the four workers, one of whom required a Spanish interpreter. The interpreter was also an EDD auditor.

Of the four workers sampled, two were licensed subcontractors receiving 1099s. One worker was a licensed handyman and also received a 1099. The fourth worker actually worked for one of George’s subcontractors.

The EDD auditor did not bother to send out anymore contact requests. From the above “sampling” the auditor concluded that all workers and day laborers should be reclassified as W2 wage earners.

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.

George’s auditor did not conduct a proper representative sampling. One of the first things the EDD reviews in deciding the hazards of litigation for purposes of arriving at a settlement, is whether the auditor conducted a proper sampling. If a proper sampling has not been conducted, the hazards of litigation to the EDD are substantial if an employer elects to have a hearing on the merits before an administrative law judge.

The Auditor Failed to Take into Consideration the Application of the “Small Jobs” Rule

In George’s case, the auditor failed to take into consideration the application of the “small jobs” rule.

Many of his workers and day laborers received $500 or less per year, yet the auditor reclassified each one as a W2 wage earner. Workers receiving such a small amount of compensation do not have to treated as employees and are allowed to be treated as independent contractors. These workers do not come under the requirement of Labor Code § 2750.5. They are not contractors. They do not receive a W2 or 1099.

Flawed – Non-Existent Samplings

It is clear from the small sampling conducted by George’s auditor, that the auditor did not go far enough in taking a representative sampling. In reality there was no sample taken. The auditor should have attempted to interview more workers on the list provided by George. The auditor was obligated under the Bill of Rights to do a better job.

George deserved and was entitled to a level playing field. The auditor’s poor findings cannot be used as evidence relating to the reclassification of any worker for any year in issue.

Conclusion

An EDD audit can and should be attacked and challenged if the auditor fails to take a proper sampling.  This challenge can be done through the settlement process by convincing the Settlement Unit that there is a lack of merit to the audit. I recommend going the settlement route first. If settlement negotiations break down the matter should be taken before an administrative law judge.

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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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