What to Expect at the EDD Audit Meeting
First, the auditor will conduct an entrance interview with the employer or with their designated representative to explain the purpose of the audit and its process, gather general information about the operation and organization of business and accounting records, and will answer any questions.
Only then, will the auditor review records. Payroll systems to be checked by EDD can be as basic as a manual system with only a check register and individual earnings records or as complex as a computerized double entry system on an accrual basis.
Provisions of the California Unemployment Insurance Code (CUIC) require employers to keep payroll records providing a true and accurate account of all workers (employed, laid-off, on a leave of absence, or an independent contractor) and all payments made. Consequently, the type of system taxpayer should use should meet the needs of your business and EDD requirements.
Requirements are explained in EDD’s California Employer’s Guide.
The auditor will review employer’s books and records to:
- Verify the business ownership and type of entity (sole proprietorship, partnership, corporation, other)
- Verify that all individuals paid for services have been properly classified as either employees or independent contractors in accordance with the provisions of the CUIC and the common law test as applied by the California Supreme Court
- Discuss any unreported payments made for personal services and the nature of the working relationship(s) with employer and the worker(s). Based on the facts obtained from the records, input from the employer, and discussion(s) with the worker(s), the auditor will determine whether the worker(s) are employees or independent contractors.
In addition, if employer’s account has been selected for a complete audit, the following tests will be performed:
- Verification that the employer’s acknowledged gross wages and taxable wages have been properly reported.
- Verification that the employer has correctly withheld and reported personal income tax for wages paid to employees.
Please note that the EDD’s employment tax audit information will be made available to the IRS under an exchange agreement and the IRS may use the information in the administration of its own tax program.
An audit begins with the examination of records for a test year. The test year is generally the most recent completed calendar year. If differences are found in the test year, then the examination may be expanded to include the records for the entire period covered by the audit.
To expedite the audit process, the employer must ensure that all records are available to the auditor.
When it comes to employment classification, the tax auditor has the discretion to define and apply a list of factors to determine whether a worker is an employee or an independent contractor, which brings us around to the relationship between employment classification and payroll tax audits.
The EDD auditors always assess the factors used to determine employment classification (which are highly subjective) in their favor; therefore, it is more difficult to convince them that a contractor is not an employee. One more thing, a worker can be an independent contractor according to the IRS and yet be an employee in the eyes of the EDD.
As a tax attorney, the problem that I encounter is that most businesses adamantly believe that their independent contractors are truly independent contractors. My understanding of what an independent contractor is based on the law in California and a lot of times, how the EDD looks at independent contractors is much different from our client’s understanding of what constitutes an independent contractor.
The same thing goes for payments towards officers and other payments that perhaps should be reclassified as taxable wages.
How Long Does the Audit Take?
If everything is done correctly, the payroll tax audit process should not take any longer than six months. It is a lot of time, I know. You think, "They are going to go through my payroll records for six months."
The reality is, from the time that you get the initial notice, to the time the case gets assigned to an auditor, to the time you have the meeting, to the time the auditor works on the report, to the time it gets finalized, that is about a six-month process.
The best thing that you can do to try and get this process over with quickly, is to come in with a very well-organized plan and a very well-developed presentation to lead the auditor through the process.
The more boxes you can check for the auditor initially, the more that you can help them write their report. The more that you can address the issues in that report, the faster your payroll tax audit is going to move and the more quickly you can get yourself out of trouble.
If you are up against an EDD audit, I encourage you to get a second opinion on the risk that you are going to face. Literally, thousands and thousands of dollars could be at stake here. Why not give me a call?
Brotman Law is staffed by a team of experienced attorneys and legal professionals who are on top of their game when it comes to payroll tax audits. It is not our first rodeo and we know how to take control of the audit to minimize the amount of damage to our clients.
At the very least, come talk to me to assess your risk and determine what needs to be done to mitigate the fallout. Just give us one hour — it is less time than you would spend on the back nine and well worth it.
I am not necessarily saying that you need to hire a tax attorney, although in most situations it is a good idea when there is an element of risk. At least seek the advice of a professional so that you know what you are walking into and do this before you contact the California payroll tax auditor.