ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – FAQs ABOUT EDD AUDITS, ASSESSMENTS, AND SETTLEMENTS – PART 1
By Robert S. Schriebman
This is Part 1 of a 2 Part series.
I have been representing clients in EDD audits and before the California Unemployment Insurance Appeals Board (CUIAB) for decades. I also get a lot of telephone calls from tax professionals seeking my advice about EDD related issues that have crossed their desks.
People have asked me a lot of questions; most of them I can answer, and some cause me to scratch my head. Covid 19 changed the way the EDD does business. Audits were down and most EDD auditors worked remotely from home and rarely came into their offices. People had employment-related problems and unique issues generated by Covid.
In this series of articles, I would like to pass onto you some of the more common questions that have been put to me.
What event has triggered the EDD to select my company for an audit?
There are many reasons an employer is selected for an audit. The most common reason is due to former workers filing for unemployment benefits who told the EDD the employer treated them as an independent contractor.
During the pandemic, the EDD granted benefits to all who applied including acknowledged independent contractors.
EDD policy calls for an automatic audit when a benefit-applicant states he/she has been treated as an independent contractor. Some believe that the granting of benefits to independent contractors provided audit leads for the EDD to conduct future examinations.
If I do not respond to the audit notice, what can I expect?
This is never a good idea and never the right path to take when you are notified of an audit. This applies to an audit by the IRS, FTB, and EDD. You cannot avoid an audit by burying your head like an ostrich. The worst thing you can do in an EDD audit is to conduct yourself in such a way where the auditor’s notes reflect that you have been an uncooperative taxpayer. No judge will give you a break if the auditor’s notes reflect this.
If you do not respond to the first “Inquiry Concerning Records” audit notice, you may go a few months before the EDD sends you a second audit notice. If you do not respond to the second notice, you can expect a telephone call from your assigned auditor. One thing for sure – the EDD will not disappear.
Must I comply with the 14-day deadline?
Ideally the EDD wants you to contact them within 14 days of the receipt of the audit package in order to schedule an examination. This deadline does cause quite a bit of stress. Most people get the audit notice only a few days before the 14-day deadline expires. What to do? The EDD is very flexible about this 14-day deadline. I have never seen a situation where it is strictly enforced. If you need more time together up your documentation and/or seek professional advice, the best thing to do is to call the EDD and tell them you need additional time. They will be happy to give it to you.
May I stop the audit while I seek professional advice and/or representation?
You have the absolute right to inform your assigned auditor that you need more time to comply with any requests or demands for documentation while you seek professional advice. I have heard auditors tell employers that they do not need to hire a tax professional and that they can work with the auditor on a one-to-one basis. I respectfully disagree. I have also found that auditors who tell you that you are wasting your time and money retaining a professional, are very aggressive and tend to be bullies. If an auditor refuses to give you the time you need to seek help, you should ask to speak with the auditor’s supervisor. Remember – the auditor is not your friend.
What is the Employers’ Bill of Rights?
EDD Publication DE 195 is a short two-page publication that discusses your rights during both the audit and collection processes. While there is not much information about your rights during an audit, there is some very important language stating that you have a right to an impartial audit and a full explanation of the audit findings. You also have the right to have someone, such as an attorney, enrolled agent, or an accountant, present during the audit to represent you in your absence. You have a right to appeal the audit findings.
I have always found it strange that the EDD never sends this publication along with the initial audit package. Most people do not know that they have a right to seek professional advice. Another interesting point in this regard is that your representative does not have to be a professionally licensed tax practitioner. Anyone is allowed to represent you during the audit process.
What may happen if I refuse to give the EDD any records relating to my business?
This is one of the biggest mistakes you will ever make when it comes to the EDD or any taxing agency of California or the IRS. Both the auditor and management will consider you to be a hostile taxpayer. The EDD will continue the audit and will issue a Notice of Assessment based upon pure estimation. An estimated assessment will not be considered for settlement resolution by the EDD Settlement Office. If you do not file a timely petition with CUIAB, the estimated assessment will become final, and you will be turned over to a collector. You may also be exposed to a personal-level assessment if you do business as a corporation or an LLC. If you file a timely petition, eventually your matter will be assigned for a judge hearing. The judge will not be happy with you and will either rule in favor of the EDD or remand the matter back to the EDD for a real examination where you will be forced to produce your books and records. There is also risk of IRS involvement in your matter.
I issued W2s to my employees and 1099s to the independent contractors. Why am I being audited by the EDD?
Just because you issued W2s and 1099s does not make you immune from an audit. The EDD wants to look at your records to determine if the W2s and 1099s are accurate. The EDD will also be looking for workers who should have received one or both of these forms that you failed to issue. Lastly, the EDD wants to determine if the 1099 recipients are misclassified and should have been treated as employees under AB-5 and AB-2257.
I do business as a wholly owned corporation, but I have never had any employees. I hired only independent contractors and never filed EDD payroll tax returns – So, I am bullet-proof for any EDD assessment, right?
Wrong! If you are an officer of your wholly owned corporation, you are automatically a statutory employee. The EDD will assess you compensation based upon their studies and external references. The EDD will attribute unreported compensation based upon their internal documentation. Unfortunately, many EDD auditors do not bother to review corporate bank statements and tax returns to determine if your corporation had sufficient income or cash flow to reconcile with their projected assessment. Stiff penalties may be assessed against your corporation for the failure to issue you a W2. The EDD has quite a large n umber of penalties and does not hesitate to assess as many of them as they can.
How far back in time can the EDD audit me when I have not had any employees and never filed EDD payroll tax returns?
The controlling audit statute of limitations in the EDD code is Section 1132. The standard audit period is 12 calendar quarters or 3 years. This is the usual audit period when quarterly and annual payroll tax returns have been timely filed. The EDD must have “just cause” to increase the basic audit period. If no returns are filed, the auditor automatically has good cause to go back as far as 8 years. The standard of good cause is always up to the auditor. These days I am seeing more 8-year audits. This poses a real problem for employers who keep records only back 6 years upon the advice of their accountant or tax return preparer.
I do business as an S Corporation and accurately report my income on my FTB and IRS income tax returns. Why is the EDD auditing me?
S Corporations have many issues aside from worker status issues. The EDD is going to want to know if you have corporate payments of health insurance premiums and they are going to check to see if you received reasonable compensation (see above). The EDD will also want to look at corporate credit card statements to see if the corporation has paid personal expenses to determine if additional compensation should be reported. There are also issues of unreported additional compensation such as unpaid loans to shareholders.
In Part 2, I will review another 10 frequently asked questions.
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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