Ask The Edd Attorney What Are The Questions That The Edd Auditor Will Ask And How Should I Respond?
By Robert S. Schriebman
It is always a good day when you receive a call from any tax auditor telling you that the audit is completed and there will be a “no change.” Yesterday, October 14, 2014, was such a day. The EDD auditor assigned to audit my general contractor client called to inform me that he completed his examination with a “no change.” These magic words mean that there will be no assessment issued and the likelihood of another audit in the near future will be minimized. Time to take my wife out to dinner and raid my Scotch collection!
The auditor was highly professional, and he went to great efforts to keep his requests for documents and other information relevant to the employee-independent contractor issues that were the primary objectives of his examination. Naturally, my responses and the documentation that I provided were also relevant.
The key to the successful resolution of any tax audit is relevancy to the objectives of the audit. Too many auditors conduct “fishing expeditions” where they ask for a broad range of documentation and information hoping to find something to hang an assessment upon. Control of the flow of information in a tax audit, especially an EDD audit, is crucial.
In Part 1, we discussed the first 13 of 27 “standardized” questions that the EDD sent to my client for response. In Part 2 we will review the rest of the questions, numbers 14 – 27. I believe that the way my client and I responded to all twenty-seven questions helped bring about the “no change” results.
Before reviewing questions 14 – 27, it is important once again to review the US Supreme Court decision in the famous Powell case. Redundancy can be very useful.
In 1964, the U.S. Supreme Court issued its famous Powell decision 379 U.S. 48 (1964). The case involved an interpretation of Code § 7602. This is the basic administrative summons provision of the Internal Revenue Code. The Powell case did not permit the IRS to go on a “fishing expedition.” That is to say, it did not give the IRS carte blanche to look over all of the taxpayer’s books and records in the hope that something could be found. The IRS must have a specific set of records or a specific reason before a summons can be validly issued. These rules apply to any taxing agency including the FTB, BOE, and the EDD.
The Powell decision gave us four key elements to determine whether or not the demands of any taxing agency are proper. These key elements can be applied to EDD audits in the same way they were applied to IRS audits. Each element must be met in order for the EDD to make a valid request for information and documentation:
- The IRS audit investigation must be conducted pursuant to a legitimate purpose. The usual EDD employee versus independent contractor audit is usually done pursuant to the EDD’s right to investigate worker’s status and the proper treatment of workers under the tax and labor laws.
- The questions or documentations sought must be relevant to that legitimate purpose. In other words, will the information sought throw light upon the legitimate EDD inquiry?
- The information the EDD wants must not already be in its possession. Tax auditors lose things. When they do they want you to resend them the information or documentation. This is a judgment call on your part. Choose your battles carefully.
- The EDD needs to take the required administrative steps before a subpoena. The issuance of a subpoena is a rare event. When this does happen it usually means that a taxpayer is very uncooperative or has been unresponsive. If you get a subpoena, be smart – call an attorney. You may have exposure for serious and several EDD penalties.
For more information on the Powell case see my book entitled How To Practice Before The New IRS, Commerce Clearing House, 1999
With the Powell case in mind, let us look at the second half of these official EDD audit questions:
Caveat: It is important to keep your answers accurate but short and succinct. When a person is being audited there is a risk of saying too much. Remember, the “tax man” is not your friend.
14. Can you explain how you generate a paycheck? Is the information from a timecard? How do you calculate the deductions?
Sample Answer: We issue paychecks based on time cards filled out by employees and approved by a supervisor. The hours are called into our outside payroll tax company. The payroll tax company calculates and deducts taxes and other withholdings.
15. Who prepares the paychecks for you? Quarterly returns? W-2 & W-3?
Sample Answer: All payroll checks are written by our outside payroll tax company. This company also prepares our W-3 and W-2s.
16. Do you engage the services of individuals that you considered not to be your employee?
Sample Answer: All services by non employees were performed by outside currently-licensed subcontractors.
17. If yes, what types of services did they perform for you? Please provide copy of their CSLB license, business card and/or invoice. Please provide contact information.
Sample Answer: We are a General Contractor. We hire independent and currently licensed subcontractors for whatever jobs are necessary. We retain copies of current subcontractor’s licenses which have previously been sent to the EDD.
18. Did you call a tax professional to get advice on the status determination of the individuals that performed services for you? How did you arrive at the status determination?
Sample Answer: Not relevant. We hire only currently licensed contractors.
19. As a general contractor did you verify to see if the contractors/subcontractors you hired have a valid license with Contractor State License Board (CSLB) before you hired them to work on a project?
Sample Answer: See answers 16, 17, and 18.
20. Who is responsible for the preparation and issuance of the 1099s?
Sample Answer: Our outside independent CPA firm.
21. Confirm mailing address.
Sample Answer: 1812 Overture Drive, Los Angeles, CA 90024
Caveat: Questions 22 – 26 may be a hidden trap for the unwary. These questions, if not answered with great care, may subject you to personal liability for unpaid corporate assessments pursuant to CUIC § 1735. It is always a good idea to consult with an experienced tax professional, especially if you believe you may have personal exposure.
22. Who managed and directed entity operations?
Sample Answer: All corporate operations were conducted by Mary A. Taxpayer.
23. Who determined what bills would be paid?
Sample Answer: Mary A. Taxpayer
24. What business expenses were paid with corporate/business funds?
Sample Answer: All ordinary and necessary business expenses.
25. Who authorized these payments?
Sample Answer: Mary A. Taxpayer
26. Who signed these checks?
Sample Answer: Mary A. Taxpayer
27. Who did you want me to discuss the audit results with (Exit interview).
Sample Answer: Our attorney, Robert S. Schriebman.
An EDD attorney, Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States.
As a trusted EDD lawyer, Robert S. Schriebman 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.
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.