ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – SHOULD YOU OBTAIN AN ADVANCED WORKER STATUS RULING FROM THE EDD? – PART 1
By Robert S. Schriebman
An employer may seek an advanced ruling from the EDD concerning the proper status of a worker. The employer may wish to treat the worker as an independent contractor and wants a blessing from the EDD just in case there is an audit in the future. Over the years, several clients have sought my advice on whether or not they should apply for an advanced ruling on worker status issues with both the IRS and the EDD. I have consistently advised them not to do so because of my belief that these types of rulings expose an employer to an audit. I still hold fast to this belief. If you are seeking an EDD advanced ruling, you may contact the EDD’s Taxpayer Assistance Center at 1.888.745.3886. You may also complete EDD Form DE 1870, but the last revision of this form occurred in 2018 and has not kept up with either AB-5 or AB-2257. In this series of articles, I will review key questions asked in the application form and give you my opinions to what exposure you may have to a possible audit. If you are audited, the responses you gave in the application form may be used against you. This is Part of a series of article that will discuss the worker status questionnaire.
Questions and Answers
Has this issue been the subject of a prior or current EDD audit, benefit claim investigation, hearing, or prior EDD ruling?
Has any other governmental agency ruled on the status of services performed by the worker or any other person performing the same or similar services?
The “issue” is the status of the worker. If there was a prior EDD audit and the worker, or class of workers, were determined by the EDD to be employees, the EDD will not now change its position. The more important issue is whether the employer has been subjected to an IRS examination in the past. Even if the IRS audit never touches or concerns worker status issues, the employer may now have an automatic pass to treat the worker or class of workers as independent contractors under the “safe harbor” provisions of the Revenue Act of 1978. The EDD cannot fault you for treating the worker as an independent contractor even though the EDD does not have safe harbor rules. If there has been a prior IRS audit, you may want to consider not following through with any EDD ruling.
The IRS does not have to give you a written ruling on a worker or class of workers. The fact that the IRS audit occurred is sufficient. This is true even if the IRS only examined items of income and ordinary, necessary, and reasonable expenses. The IRS auditor can totally ignore any worker status issues and the employer will still be given a get-out-of-jail free card.
If the entity is a corporation, is the worker an officer of the corporation?
Officers of corporations are, by law, considered statutory employees. They must be given a W2 and be placed on salary. It is a common occurrence in the construction industry that corporate officers such as a president or CEO take draws and report them on individual income tax returns as ordinary income. While this may properly reflect income, it deprives both the EDD and the IRS of payroll tax revenue. An EDD auditor will severely penalize the corporation when the auditor sees a history of draws with no W2 or 1099. There are two stiff worker information return penalties amounting to $50 per individual per year and an additional almost 13% penalty on officer compensation.;
In rare events, a corporate officer may receive both a W2 and a 1099 in the same year. Most EDD auditors are not aware of this and when they see an officer receiving both forms, a red flag goes up and the penalties start to fly.
Were the services performed under a written agreement or contract?
Contracts are important and they are commercial necessities. Whenever I get a request to draw up a bullet-proof employment agreement, I always refuse. When it comes to the EDD, the typical auditor will ignore the contract and reclassify the worker as an employee. The most important part of a contract, as far as the EDD is concerned, is that it states the worker is responsible for his/her own taxes and filing of tax returns. A contract that does not have this provision will be ignored by most EDD auditors. Administrative law judges, on the other hand, are trained lawyers who understand the importance of the contractual relationship.
If the agreement was not in writing, or the terms of the written agreement were not complied with in practice, describe the actual terms and conditions of the arrangement?
This question is a potential trap for the unwary and a potential confession to improper practices. You must be wary of what you tell an EDD auditor in the initial stages of an audit or if you are applying for an advanced ruling. When in doubt, say nothing, because silence may be your best friend.
This is Part 1 of several series that will examine an EDD advanced ruling questionnaire. Whatever you put down in writing today, may haunt you in the future. I am personally opposed to anyone seeking this type of advanced ruling. You are better off seeking competent counsel and being protected by the attorney-client privilege especially when it comes to exposing yourself to a potential audit.
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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