Chapter 13

What Is an EDD Audit?

If you are a California employer, then you are well aware of the Economic Development Department (aka EDD). (Hopefully,) You are paying payroll taxes to them on a quarterly basis and keeping all of your documents, such as W-4 forms, 1099s for your independent contractors, INS documentation, etc. What you might not know, is what exactly does the EDD do with all of that money you send them?

In this chapter, I am going to give you an overview of the EDD and the types of programs it finances with your payroll taxes. While it might not make paying the EDD any easier, at least you will have some idea of where your dollars are going.

I am also going to get into payroll tax audits, which I can tell you, are no fun. There are a number of circumstances that can trigger an EDD audit and I am going to talk about the most common ones (and the most easily preventable.) 

What I am going to point out is that independent contractor status is trending in the audit world. As the workforce is increasingly shifting towards a “gig economy,” the state is going to make sure that none of these workers actually are bona fide employers. 

If you are facing an EDD audit and do not know where to turn, give me a call. My firm, Brotman Law, has represented hundreds of small business clients in payroll tax audits and have come out on the winning side. This is complex stuff and something you really should not attempt to fight on your own or with your HR department or CPA.

What is the EDD?

The Employment Development Department, or EDD, is one of the largest California state departments and is responsible for administering the payroll tax regulations for California businesses and individuals.

Payroll taxes administered by the EDD include the following:

  • Employment Training Tax (ETT)
  • Unemployment Insurance (UI)
  • Personal Income Tax (PIT)
  • State Disability Insurance (SDI)

Employment training tax provides funds for training employees in specifically targeted industries to make California more competitive in business. It is withheld at a rate of 0.1 percent with a taxable wage limit of $7,000 for 2016.

Unemployment insurance, also taxed at a rate of 0.1 percent and a limit of $7,000, is part of a national program administered by the U.S. Department of Labor to provide temporary payment to individuals who are unemployed through no fault of their own.

Both the ETT and the UI are employer contributions.

Personal income tax is levied on the income of California residents and income derived from the state by non-residents. The tax rate is determined by the employee’s Withholding Allowance Certificate (W-4 or DE 4). There is no taxable wage limit or maximum tax.

The EDD and Franchise Tax Board (FTB) use these taxes to provide resources for state public services such as schools, public parks, roads, and health and human resources.

State disability insurance provides temporary benefit payments to workers who have non-work related disabilities and also is the source of Paid Family Leave benefits. The tax rate is 0.9 percent, with a wage limit of $106,742.

PIT and SDI are both withheld from employee wages and submitted by the employer to the Employment Development Department (EDD) and the Internal Revenue Service (IRS).

Most employers file and submit payroll taxes semi-weekly or monthly, although smaller businesses can pay on a quarterly basis. Very small employers can file once a year.

AB 1245 requires all employers electronically to submit employment tax returns, wage reports, and payroll tax deposits to the EDD. Before then, payroll taxes can be submitted via electronic funds transfer, credit card, and direct deposit.

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EDD Calculations, Exceptions, and Exemptions

There are special rules for family members who work for you, non-profit organizations, and special exclusions. Some employment types are not subject to PIT withholding, but wages may still be reportable.

People receiving work-relief or work-training financed by any government agency and inmates of a custodial or penal institution are exempted from ETT, UI, and SDI withholdings.

A business owner can apply for a waiver from paying payroll taxes due to reasonable cause, statutory exceptions or undue hardship. Each waiver is considered on a case-by-case basis.

Calculating withholding can get tricky when you must take into account holidays, terminations, leaves of absence and other delays. Communication between the HR benefits specialist and the payroll office is crucial for keeping tax withholding on track.

The EDD and the IRS Are Not Alike

The tax regulations in California are comparable to the federal tax rules but not identical. There are different rules pertaining to family leave and who is held responsible for non-payment of corporate employment taxes. 

There are also subtle differences in how each defines employee classification.

Where and When Problems Occur

Employee Classification

Employee classification is the area that causes the most problems for business owners. Both the IRS and the EDD are very interested in whether a worker is classified as an employee or as an independent contractor.

An employer must withhold, file, and pay employment taxes for an employee, but not for an independent contractor. The EDD looks at the employer-employee relationship to determine classification.

If a person who hires an individual to perform services has the right to exercise control over the manner, method, mode and means of how the service is performed, the worker is an employee.

Late Filing and Payment

If you file or pay payroll taxes late you are out of compliance and will owe penalties and interest on the amount of tax you owe.

Miscalculations, Underpayment and Changes to the Business

If you miscalculate taxes, you will still be assessed a penalty if you underpay. If you try to conceal the existence of a worker by paying in cash and failing to file a Form 1099, you are also in trouble.

Changes to the business, like closing or expanding, must also be reported for the appropriate amount of taxes to be calculated and submitted without fear of penalty.

EDD Audits

The key to any EDD audit is to make certain all records submitted are relevant to the situation. Any records that do not pertain to employment-related issues are not relevant.

Documents that can be requested include:

  • Check registers and stubs
  • Bank statements and canceled checks
  • General ledger and journal
  • Annual financial statements
  • Vouchers and pay out slips
  • Forms 1099

The EDD can decide to audit if a worker makes the case that he or she is an employee rather than an independent contractor (typically found out when the employee tries to apply for unemployment insurance).

Other triggers for an audit include:

  • Filing or paying late
  • Errors in time records or other statement or documents
  • Digital failures that cancel or delay payroll 

Many of these audit triggers are rooted in basic recordkeeping and employee classification and are fairly easy fixes. That is why once you survive an audit, it makes sense to implement a payroll tax compliance plan for your business. 


As you have read, the payroll taxes collected by the EDD are actually put to good use throughout the state, whether you agree with the disbursement or not. What is important is that your business is in compliance with state laws regarding employment and payroll taxes. 

It is always preferable to have your business systems in good working order before you receive an audit notice from the EDD. Usually, at that point, it is too late and the best thing we can do is try to control the audit from your side. 

If the EDD has contacted you about an audit, your best reaction is to contact me. We can devise an audit defense to minimize your liabilities. If there is any silver lining to this is that as we go through the audit process, I can see where your recordkeeping and systems are falling short. We can create a compliance plan to shore up those deficient areas and keep you off the EDD’s radar.

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