ASK THE EDD LAWYER – HOW TO AVOID EDD’S CONTRACTOR WHIPSAW, Part 2
By Robert S. Schriebman
May 13, 2015
This is Part 2 of a 2-Part Series. In Part 1, we reviewed the contents of a typical EDD Audit Report (AR) as it relates to the audit of a contractor. We learned how the EDD “Whipsaws” a contractor whether or not that contractor is required to have a license. In Part 2 we will discuss how a contractor can get prepared for an audit and how to adopt an early strategy to combat the EDD’s apparent built-in bias against contractors in general.
The term “Whipsaw” can be defined as getting the best of an opponent in spite of every effort he makes. In other words it is a literal form of “Heads I Win – Tails You Lose.”
Whether or not a contractor is required to be licensed does not seem to matter to the EDD auditor. He or she will find any unlicensed worker to be a common law employee. For example, if the general contractor is licensed the EDD will use CUIC § 621.5 for a strong presumption that any unlicensed subs are employees. If the contractor is not required to have a license the EDD will use CUIC §§ 621(b) and 13004 to hold that the 23 factor common law test applies to create a presumption that all workers are employees.
The EDD Audits the Contractor
When the EDD chooses a specific contractor to audit, the contractor will receive 4 basic documents as follows:
- Inquiry Regarding Records – This is the basic introductory letter that tells the contractor-taxpayer he or she is under audit and that a response is due within 14 days.
- Pre-Audit Questionnaire – This is a two page form seeking basic background information on the contractor’s business.
- Document Request – This is a standard form that sets forth a basic 3 year audit period, quarter by quarter. The form asks for many documents that the EDD is entitled to receive, but it also demands many documents that the EDD is not entitled to receive. I strongly advise any taxpayer, regardless of what business he or she may be in, to seek at least a consultation with an experience tax professional to determine what documents to give to the EDD and what documents and other information to withhold.
- EDD Form 231TA “Employment Tax Audit Process Information Sheet” – This is a basic publication that discusses the audit process.
(NOTE: IF YOU DO NOT RECEIVE THIS STANDARD AUDIT PACKAGE YOU SHOULD TAKE THE POSITION THAT YOU ARE NOT BEING AUDITED – EVENTHOUGH SOMEONE FROM THE EDD MAY TELL YOU OVER THE PHONE YOU ARE UNDER AUDIT.)
The Audit Appointment
After the contractor receives the basic audit package discussed above, and only after the package has been received, an EDD Appointment Clerk will call to set up a date for the audit. The EDD will want to conduct the audit at your place of business preferably. At that time you will be expected to produce the documentation set forth in the “Document Request” and you must be prepared to answer questions relating to your business and worker status. Prior to the audit conference, you should decide whether or not to be represented by an experienced EDD Tax Audit Specialist. Even if you believe you do not need representation, and you want to go it alone, you should at least have a consultation with a specialist prior to any in-person meeting with the EDD auditor.
Strategically Planning For the EDD Audit
Although we live in an electronic-computer age, it would be a mistake to simply produce computer generated documentation such as summaries and spreadsheets. I have always believed, and I have taught my students at USC, that paper is still the most important product in most audits; an EDD audit is no exception. The following is a list of the most important documentation that will get you through the typical EDD contractor audit:
- 1096 and 1099 forms for the periods in issue.
- W3 and W2 forms for the periods in issue.
- Copies of California income tax returns.
- A sample copy of any independent contractor agreement used in your business.
- A copy of your Contractors State License Board license (CSLB)
- Copies of subcontractor licenses from the CSLB
Never give the EDD, IRS, BOE or the FTB original documents to review and return to you. Original documents have a habit of getting lost or destroyed while in the government’s possession. Copies only please!
The above list is not all inclusive; it is only a very basic list, but it is a good start when under audit.
It is very important from the beginning to be cooperative with your assigned EDD auditor but, at the same time, you must be careful that you do not cooperate to the point where the assigned auditor assesses you harsh tax bills with many penalties. It is always a good idea to show the EDD auditor any subcontractor license. I also advise my contractor clients to produce copies of subcontractor websites and other evidence that they hold themselves out to the general public to provide contracting services. Business cards are also important to show that subs are in business for themselves.
If you have not issued 1099s or W2s to your workers you can expect stiff fines that when assessed have no prepayment appeal rights. I always recommend professional representation for contractors with this problem.
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.
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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