ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – NAVIGATING YOUR WAY THROUGH ALL THOSE EDD PENALTIES – PART 2
By Robert S. Schriebman
This is Part 2 of a 2-Part series that will discuss the most common EDD penalties assessed during an EDD audit.
Employers audited by the EDD are likely to receive penalty assessments along with the usually assessments for the basic payroll taxes: UI, DI, ETT, and PIT. It is rare to receive an audit assessment with no penalties, just taxes and interest.
When an EDD audit is completed, the auditor prepares an Audit Report (AR). A portion of the AR has a section devoted to the assessment of penalties and the explanation by the auditor of why the specific penalty was assessed. The penalty section is a very important part of the AR and should not be ignored. You are entitled to receive a copy of the AR, but you must ask for it; it is rarely given voluntarily.
How Are Penalties Removed?
The process of removing an assessed penalty is known as “Abatement.” Many EDD penalties, in the EDD’s inventory, can be abated for “good cause,” one penalty can be abated for “reasonable cause,” and some penalties have no grounds for abatement at all. There is no definition in the body of EDD law that defines “good cause.” The only references are portions of Title 22 Regulations that state that good cause depends upon the facts and circumstances. To me there is no material distinction between good cause and reasonable cause. There are standards for reasonable cause.
The best places to find a definition of reasonable cause are the Internal Revenue Manual (Chapter 20), and the US Supreme Court Boyle decision (Boyle v. U.S., 469 US 241 (1985). Boyle held that reasonable cause is defined as ordinary business care that a prudent business person would use in the conduct of his/her day-to-day business affairs. It does not require super-human effort or intelligence.
Let’s Look At The Rest Of Those EDD Penalties
In this discussion I will set forth the specific code section of the California Unemployment Insurance Code (CUIC). I will state a brief overview of the penalty, its amount, and the grounds for abatement. Here I will discuss the more common penalties assessed during the EDD audit process. These penalties fall into several groups: Failure to File Penalties, Negligence Penalty, Fraud and False Statement Penalties, Assessment Finality Penalty and Worker Information Return Penalties.
Failure to File Penalties
CUIC § 1126: This penalty is 15% of the taxes assessed. The penalty is for the failure to file quarterly and annual payroll tax returns. This is a commonly assessed penalty and you can expect it whenever you have a situation where the employer treats all workers as independent contractors, even corporate officers. As a result no returns are filed. Corporate officers are by law deemed “statutory employees.” Quarterly and annual returns must be filed for them.
Abatement: No grounds for abatement are stated in the statute. I believe that reasonable cause will be a sufficient basis for abatement. This is especially true when there are many factors in favor of the employer treating workers as independent contractors.
CUIC § 1126.1: This penalty is for the failure to register with the EDD and to obtain an official EDD account number. Unfortunately, many small businesses cannot afford the best legal and accounting advice from reputable lawyers and accountants. They go online to form their corporations and LLCs on the cheap. While the services provided by reputable legal advisory websites, provide the basis for the formation of the entity, they do not get into matters relating to the registration of the new business with the State and Federal taxing agencies. As a result the entrepreneur blissfully goes into business, only to be penalized by traps for the unwary. The EDD is there ready to issue a penalty of $100 per unreported employee to be assessed on the payroll tax quarter containing the highest number of unreported employees.
Abatement: No grounds for abatement are stated in the statute. This is sort of like being a little bit pregnant, (no such thing), the employer either registered or failed to register.
CUIC § 1127: This is by far the most popular of all the penalties in the EDD’s arsenal. Most of the time this will be the only penalty assessed. This is very subjective on the part of the EDD auditor; if there is any reason at all for the assessment of this penalty, you are going to get it! I am also finding that the EDD’s Settlement Unit is showing reluctance to abate the penalty in the interest of settlement.
There is a current trend with EDD auditors to ask, at the beginning stages of the audit, whether or not the employer sought professional advice on how to classify workers. The auditor will want to know the name of the professional advisor and when the advice was obtained. Unfortunately most employers, especially general contractors, never seek professional advice about how to classify workers especially unlicensed subcontractors. There are provisions in both the Labor Code and the CUIC that clearly state unlicensed subcontractors are employees of the general contractor by operation of law.
Some clients took that extra step to obtain professional advice. However, either their advisor is deceased, long ret0red, or moved away. These factors and events are accepted by EDD auditors as due diligence on the part of the employer.
Abatement: Good cause
If you are currently being audited as an employer, or if you are a professional representative, you must be proactive. Don’t wait for the auditor to ask you about your reasonable basis for treating a worker as an independent contractor. Tell the auditor right away and let it be a part of the audit record. I recently avoided the Negligence Penalty for a client with two separate businesses because I took the initiative to notify the auditor in writing about how my client obtained professional advice. I named the advisors, a CPA firm, and the auditor accepted this explanation. If you do not inform the auditor, you run the risk of being assessed the Negligence Penalty only to fight for its abatement after the Notice of Assessment has been issued.
Fraud and False Statement Penalties
CUIC § 1128(a)(b): These penalties are rarely assessed. But if they are, the employer will be in a world of hurt. These penalties are assessed for lying to the auditor, withholding evidence, or providing false books and records. These are the only penalties in the EDD arsenal that are keyed to § 6041A of the Internal Revenue Code. These penalties are assessed in addition to the Negligence Penalty and the Failure to File Penalty (CUIC §§ 1126 and 1127).
The penalty under § 1128(a) is 50% of the tax assessments. The penalty under 1128(b) is also 50% of the tax assessment.
If the EDD is going to assess these fraud penalties, you will see them stacked along with many other penalties. You can wind up with an upside-down situation where the penalties equal or exceed the tax portions of the assessment!
Fraud penalties cannot be settled with the EDD’s Settlement Unit. You have to take the matter before the CUIAB and hope to make a deal with the assigned EDD attorney.
CUIC § 1142(a)(b): These penalties are usually assessed against individuals seeking UI benefits. They are assessed for making false statements and false representations regarding the termination of employment. The penalty is not less than 2 or more than 10 times the claimant’s weekly benefit amount.
Assessment Finality Penalty
CUIC § 1135: This penalty to me is unfair and unwarranted. It plays a part in the settlement process and also comes into play if an assessment goes to default because a timely petition was not filed timely or at all. This is a 15% penalty imposed solely for the failure to pay an EDD assessment in full within 30 days.
This penalty is especially harsh and unwarranted during the settlement process. Let’s look at an example. Suppose you have a matter pending before the EDD’s Settlement Unit. The ultimate settlement, although substantially smaller than the original assessment, is still quite large and you need to pay it in installments. Installment payments are allowed in the settlement process. Because you cannot pay the settlement in one lump sum, there is, by law, a 15% penalty on the unpaid balance. So if your agreed settlement is $50,000, and you want to pay it off in 10 installments of $5,000 each, there is a 15% penalty imposed upon the $45,000 unpaid balance or an additional $6,750. Therefore, a $50,000 settlement becomes a $56,750 settlement. Remember too, that there is interest charged by the EDD on the unpaid balance – a double whammy.
Abatement: Absolutely none!
Worker Information Return Penalties
CUIC § 13052 and 13052.5: This is a two-tiered system of penalties that are each assessed concurrently. There is a $50 penalty for failure to furnish a worker a W2 or 1099, or furnishing a false information return to the worker. For example, paying the worker cash and issuing a W2 or 1099 for smaller amount that is then reported on the worker’s income tax return. By far the larger penalty is based upon the compensation payment to the worker. This percentage is currently about 13% of compensation and may increase based upon the cost of living. There are many articles on this website that discus these penalties at length.
Abatement: Reasonable cause. I currently have several cases pending before the CUIAB and the EDD’s Settlement Unit where I have made numerous arguments for abatement. At this point in time I cannot tell you which arguments are going to be successful – so stay in touch.
This concludes Part 2 of a 2-Part series giving you an overview of the most common EDD penalties assessed during the audit process. Too many auditors assess too many penalties almost as a knee-jerk reaction. All too often valid grounds for assessing penalties are not present. This is especially so when the employer has a reasonable basis for treating a worker as an independent contractor. Many variances between W2s and 1099s and the employer’s records are minor and can be attributed to honest mistakes and clerical errors. Most errors are not just material. My personal philosophy has always been to never take a penalty lying down; get up and fight it!
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 40 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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