After verifying payroll and payroll tax withholdings, the EDD will next go through and verify all the workers that the business issued 1099s to. This is what is known as the EDD Independent Contractor Test. First, the EDD auditor will go through each 1099 worker in detail, one by one. Even 1099’s that were issued to businesses, landlords and others that are clearly not subject to payroll tax withholdings, you can pretty much count on the EDD auditor going through each one and verifying who was issued a 1099.
The independent contractor test is essentially a verification of whom the 1099 was issued to and whether or not it is a legitimate independent business or contractor. The EDD auditor is going to look for evidence that your independent contractors are holding themselves out in an independent business capacity. The EDD auditor is naturally going to for evidence of this in the form of a website look for a website, information on Facebook, Twitter, Yelp and other social media platforms, and through the Secretary of State's website.
In addition, for individuals that are 1099'd, we are increasingly seeing auditors go to LinkedIn and looking at the contractor LinkedIn profiles. They are looking for a few things with these profiles. First, they are trying to look for evidence of professional credentials or any other criteria that they had they may establish them as an independent working professional. In contrast, they are also looking for evidence that would link the independent contractor to the subject company as an employee versus as an independent contractor. At Brotman Law, our standard practice is to do a social media check to make sure independent contractors are not inadvertently holding themselves out as being employed by ABC company.
With most corporations that were issued 1099s, if they are legitimate businesses, they are going to pass the EDD Independent Contractor Test. It is very rare that you would have a situation with a company that has been 1099'd, unless there is a very flagrant circumstance or something that just does not make sense, that the EDD is going to go back to try to classify that company or the officer of that company as an employee.
However, occasionally, we will encounter situations where employers (certainly not under the advice of counsel, will have their workers set up dummy corporations and issue payroll through dummy corporations. In those circumstances, the EDD will look through their corporation. By not seeing any evidence that they are a legitimate business and will try and assign wages to the subject officer and collect payroll tax on that. But for the most part, any 1099s that are issued to corporations, so long as they are legitimate, are going to be glossed over by the EDD auditor.
It is a much different story with respect to individuals. In contrast, the EDD is really going to look at 1099s that were issued to individuals with a lot of scrutiny because this is the principal focus of the Employment Development Department’s compliance effort. As such, the state focuses on individuals during the EDD Independent Contractor Test in order to determine whether or not these people are independent contractors or not.
This does not necessarily mean that these people are not independent contractors. I can think of several occupations and industries that we have some across with true independent professionals working in some capacity for our clients. We have music industry professionals, like people who do recordings, and things like that, who are 1099 workers. We have car salesmen, who are 1099 commission sales people. There are hairdressers, dietitians, physical therapists, nurses, doctors, attorneys, dentists, and real estate professionals where you have a person who is not holding a business trade name, who is operating as an individual, but still running a legitimate business. There is no question that these people are independent in certain circumstances, but just understand that you are going to encounter the greatest amount of scrutiny during the EDD independent contractor audit.
What the EDD auditor does during the EDD Independent Contractor Test is that they are going to trying interview most of the individuals who were issued 1099s. If there are a large number of them, then the EDD auditor will take a sample and go based on the sample interviews. Really, what the EDD auditor is trying to do is segregate workers into crude job categories, lumping all of your people into a box, and make a determination on that category. For example, they may say, "These people are salespeople. These people are professional services people, these people are-- whatever."
It is within those categories that you real fight is going to be. Your objective during the EDD Independent Contractor Test is to win each category and win the workers within each categories, so that their salaries don’t get reclassified as W2 wages (and subject to California Payroll Tax). You want to make sure going through and doing your prep on each of the individuals within the job categories, so that you have enough ammunition to assert that each one of the workers in the category is an independent businesses. Because they are going to go through an interview process. The EDD is making the counter argument. They are going to be looking at how much control you as the employer has over these workers and whether the duties of the 1099 contractors are essential to the revenue generating functions of the business. This is the crux of winning an EDD audit.