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In Today’s Economy: Common Ways Businesses Get Into Trouble With the EDD and IRS

Tough Times And Downward Spirals

I don’t have to tell you how difficult it is these days for businesses to survive in the current economy. Will 2010 really be the end of the current recession? Hardly a week passes when we read of a major company contracting its operations, laying off good people, or closing its doors forever. Behind closed doors decisions are quietly made to postpone the payment of employment and withholding taxes in order to meet minimal payroll or pay rent and utilities. In California employment and withholding taxes are close to 20% of gross payroll. A businessperson whose accounts receivable are questionable may say, “I will not make my payroll tax deposits for this quarter, but I will make them up when I get that check from my big client next month”. But that check never seems to come or, if it does, it is smaller than anticipated. Soon one month’s payroll taxes become one quarter’s payroll taxes and before you know it a downhill spiral begins. Time goes by very fast and what was a conscious decision not to make one or two payroll tax deposits becomes a failure to pay quarterly EDD and IRS payroll taxes for one year. The doors of the business remain open, domestic expenses are made and kids are sent off to college, but the price can often be two or three years of delinquent payroll taxes. Tax delinquency notices are discarded or placed in a “to do” drawer.

Cash Under The Table

Some businesses pay their workers cash “under the table” and think they have pulled the wool over the eyes of the taxman. However, what do both the employer and employee do when it’s time to file quarterly or annual tax returns? Things never go as planned.


In a tight economy where survival may depend upon the saving of payroll taxes, many small corporations treat their employees as independent contractors to avoid withholding and employment taxes with both the EDD and IRS. As part of this process, businesses fail to file quarterly employment tax returns.

Everyone seems to be happy with this arrangement until the business contracts further and people have to be laid off. An unemployed worker-contractor most likely make a trip to the EDD to seek unemployment benefits. He or she may very well get those benefits especially if the EDD is fully informed as to how the owner goes about treating workers as contractors. Now the EDD has a new business to audit and to assess stiff delinquent employment taxes together with penalties and interest. The owner of the corporation may also become personally liable for those taxes, penalties and interest – a true 100% penalty. The IRS may also get involved at both the corporate and individual levels. Before he or she knows it, there are four possible levels of attacks by both the IRS and EDD. It’s a whipsaw of the worst kind.

Owners of small corporations either do not file quarterly returns, or file these returns stating that they have “zero” employees. At the same time these corporate owners fail to realize that they are by law “statutory employees”. This means that it is impossible for a corporate owner-employee to legally be an independent contractor.


Companies strapped for cash, and effectively using employment taxes, government money, to pay their expenses, often file understated quarterly tax returns because they have been told by their tax advisors that the IRS and the EDD never audit these types of returns. Well, guess what – the IRS plans to audit at least 6,000 U.S. companies in the near future to ensure compliance with federal employment tax obligations as part of a research program that will begin in February, 2010.

Different types of business organizations will be looked at by the IRS. These types of businesses include partnerships, limited liability companies, and S corporations. According to the IRS this audit campaign will be very broad and across the board for all filers. You can be sure that the EDD will take a great interest in the results of these IRS audits and may conduct their own “me too” audits to get California’s share.


The IRS has a name for taxpayers who fail to make proper deposits and try to play catch-up in subsequent quarters. These people are known as “pyramiders”. They never seem to catch up. They are constantly incurring very steep penalties and interest, quarter after quarter after quarter. I have one client who has paid so many quarterly penalties that he could have taken this money and bought one of the finest homes in town. The IRS knows who you are and they have teams of collectors who are assigned to monitor your account. When and if the IRS decides that the taxpayer is in a hopeless downward spiral, there are many options open to them including criminal prosecution and closure of the business. The assets of the business are seized by the IRS and sold at public sale.

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.