Chapter 01

EDD Audit Process: Triggers, Penalties, Letters & More

California taxpayers and business owners panic after receiving an Employment Development Department (EDD) audit notice from the state tax authority. The California EDD investigation division accesses business owners' unpaid payroll taxes. If taxpayers disagree with the proposed assessment, they can proceed through the California EDD audit process.

The state of California tax authority investigates business tax records to differentiate independent contractors from classified workers. As a taxpayer and business owner in California, you may face an EDD notice if you hire an independent contractor. But don't worry, we'll discuss the California EDD audit process, its triggers, and penalties.

What is an EDD audit?

An EDD audit, also known as payroll tax audit, is a process initiated to ensure the proper classification of workers in an organization and verifies business owners' compliance with the California Unemployment Insurance Code (CUIC).

The audit occurs when the government wants to make sure business owners are reporting payments made to employees properly and protecting workers' rights to benefits. If a worker applies for unemployment insurance and makes the case of being an employee rather than an independent contractor, EDD audits may occur.

The EDD audits purpose is to find inconsistencies and determine if the employer has fully paid the owed payroll taxes under California law.

What triggers an EDD audit?

Employee benefits, registry, and an independent contractor filing for unemployment, can trigger an audit from the California EDD investigation division. Furthermore, late filing of taxes, employee complaints, randomized verification, and failure to pay wages in time are other triggers. There are various Employment Development Department audit triggers, and we will discuss more below:

1. EDD benefit audit trigger

The Employment Development Department is responsible for collecting and conducting payroll tax audits of business organizations and companies. The benefit audit process is a combined effort by the EDD and employers to detect potential fraud. This process also protects the unemployment insurance fund's integrity and diligence. The EDD benefit audit occurs on a quarterly, weekly, and daily basis for employment tax and often leads to the successful detection of benefit overpayments.

What triggers an EDD benefit audit?

Random Audits

Many taxpayers wonder, what triggers an unemployment audit? When selecting employers to audit, the employment development department makes random selections. This tax authority randomly selects companies and business organizations in no particular order. The chances of facing an EDD benefit audit are relatively low, but it can happen to anyone.

Workers Compensation Insurance

If the commission or department of insurance investigates workers' compensation, the Employer Company or organization may receive an EDD benefit audit notice. The commission may conduct an audit to reclassify payments and employees.

EDD Task Force

The commission uses a task force to find inconsistencies in employers' practices that will then trigger an audit to prevent potential fraud. The EDD will send agents from this task force to interview employees about their employment and the company practices.

2. EDD new employee registry benefit audit

The New Employee Registry (NER) benefit audit is a federally required process that depends on the information employers in California present to the Employment Development Department. This audit determines whether employees receive unemployment insurance (UI) benefits. Many employees receive these benefits after returning to work but fail to report their earnings.

What triggers an EDD new employee registry benefit audit?

If an individual received unemployment insurance benefits without reporting earnings, it may trigger an EDD new employee registry benefit audit. For example, if a former employee applied for unemployment benefits, but got hired by your company as a 1099, it often leads to a misclassification audit for the EDD. The commission will review your employees classification because 1099 employees are ineligible for employment insurance after completing a gig with the employer. 1099 workers are ineligible for workers compensation because they have other clients and set work hours. 

Quarterly Wage Earnings

Quarterly wage earnings reported by employers to the EDD can be another factor that can trigger a new employee registry benefit audit. If an employee received benefits while working and failed to report the earnings, it often results in a benefit audit.

Interstate Crossmatch

The Employment Development department determines if an employee received benefits while working in another state with an interstate cross-match. The commission cross-matches wages earned from other states every quarter. If an individual receives a benefit that does not belong to the state of California, the commission may send a new employee registry audit notice. Overpaying employees can also lead to this audit, including fines and penalties.

Employee complaint

An anonymous source filing a complaint or giving tips against a business organization or company to the Employment Development Department may lead to an audit. The government authorizes the commission powers to explore complaints, and complaints often lead to an audit notice. If any employee filed a complaint against your business, consider hiring a certified public accountant (CPA) or an experienced tax attorney while preparing for the audit.

EDD audit process

The Employment Development Department (EDD) audit process starts with the commission sending an audit notice. The commission does not audit individuals, but businesses. An entrance interview, review of financial documents, requests for additional clarifications, and a proposed notice of assessment are key steps in the process. We will discuss how to appeal EDD audits and each step more in-depth.

1. Mailing of an audit notice

The Employment Development Department alerts taxpayers about auditing their payroll taxes. Taxpayers receive this notice via mail and can reply with documents and supporting evidence through the same channel.

This notice usually contains a list of documents the commission wants businesses to provide as supporting evidence. You'll find information detailing why you received an audit from the commission in the notice. Furthermore, it includes a list of questions to prepare taxpayers before commencing the audit.

2. Entrance Interview

After the Employment Development Department sends an audit notice to businesses, the commission schedules an entrance interview. The purpose of the interview is to help taxpayers understand the reasons for the audit. The agent explains the process and collects necessary information about the company.

If you have any questions for the Employment Development Department, the interview is the time to ask and get clarifications. Consider engaging a certified public accountant or an experienced tax lawyer before speaking with the commission agents during the entrance interview. Brotman Law is home to experienced and knowledgeable tax professionals that'll ensure a quick resolution to your case, even for underpayment.

3. Review of Financial Documents

At this stage, the Employment Development Department asks for financial documents with supporting evidence for resolutions. Your business ownership verification, registries and stubs, bank statements, canceled checks, and general ledger are a few documents required.

Furthermore, annual financial statements, vouchers, pay-out slips, and 1099 forms are other documents to present to the commission. Providing these documents helps the commission evaluate your records before making a decision.

4. Request for additional clarifications

The commission may request additional documents to clarify inconsistencies in taxpayers' records. Employee classification records and information regarding payroll tracking are a few other documents the commission requires to verify any disclaimer. If the information you provided is inconsistent, fines and penalties may follow.

You may provide documents that show how the business organization handles contract termination and employee misconduct. Your relationship with employers and unreported payments made for personal services are details you will discuss with the commission.

5. A proposed notice of assessment (PNA)

After the auditor receives and reviews the submitted documents, the commission issues a proposed notice of assessment (PNA) to taxpayers. The commission sends the PNA for taxpayers to access, review and request necessary changes.

The audit process length does not play out the same for everyone and depends on your level of cooperation and ability to find necessary information for the auditor. A tax attorney can help you minimize admissions that could cause problems down the road.

How to fill out an EDD pre-audit questionnaire form

The pre-audit questionnaire is designed to elicit admissions and provides auditors with adequate information for an audit plan. The EDD pre audit questionnaire form asks whether you operate year-round, full-time, or seasonal and asks for a description of your business.

This form asks how many services you provide and how many employees you have, including the employee benefits you provide. The pre-audit questionnaire form contains various sections and we will discuss them more below:

1. Business Description

The pre-audit questionnaire form requests a description of your company to help them understand the nature of your business. The Employment Development Department learns your business model through this information and incorrect information can lead to fines and penalties that can leave you financially strained.

2. Services the company provides and the number of employees

Another question on the EDD pre-audit questionnaire form is about the number of employees you have and your company's services. The EDD wants to know this information to verify the classification of your employees at the company. Whatever your business model, provide a thorough explanation and supporting documents to avoid fines.

3. Bookkeeping/accounting you use

A section of the EDD pre-audit questionnaire form requires information on the bookkeeping and accounting process you use. Many business organizations have staff accounting records, and the EDD wants to evaluate them. Consider providing information on bookkeeping records for every employee in your organization.

4. Employee Benefits you provide

The pre-audit questionnaire form requests information about the employee benefits your business organization provides in order to evaluate tax returns. If you give employee benefits, provide necessary information as requested by the form for quick resolutions.

What to expect in a meeting with an EDD tax auditor

Document assessment and audit results are a few things to expect in a meeting with a tax auditor. The tax auditor will inform you of the reasons for the audit and the required documents and records you will need to provide.

The EDD tax auditor requires your business financial documents for assessment. An EDD auditor will verify the business ownership and entity type for your income tax return. They will also verify that all individuals paid for services are classified correctly.

The meeting also involves discussing unreported payments made for personal services and the nature of the working relationship with employees. The commission also verifies that the employer has correctly withheld and reported personal income tax and state payroll taxes on employee wages for the calendar year.

It may be helpful to consult an experienced tax EDD lawyer or certified public account before meeting with EDD tax auditors.

California EDD audit penalties

If you make a late payment, the CA EDD audit calculates fines based on the time passed. The commission offers a 2% penalty for deposits made 5 days late and 5% for payments made 6 to 15 days beyond the required timeframe. If the late payment exceeds 16 days, the penalty increases to 10%,

If you fail to pay tax 10 days after the Internal Revenue Service issues a notice, the commission adds a 15% penalty to the tax debt.

If there is a fraud case, by failure to report or misclassifying employees, the CA EDD audit introduces additional penalties for state employment tax and state income tax.

Employers may get a $5,000 fine for every misclassified employee, including 1.5% of the employee's federal income tax liability and 20% of the employee's Social Security tax withholdings.

At the state level, employers can get an additional $5,000 and $15,000 fine for misclassification. If there is visible evidence of deliberate misclassification, the fine increases to $10,000 and $25,000. Employers may request a penalty reduction if they can prove there was a genuine mistake.

If employers have failed to keep records and issue itemized wage statements, they may face even more penalties.

Need EDD audit representation help?

Providing the necessary response to the EDD tax auditors challenges many taxpayers, especially when it involves business documents. While taxpayers can engage EDD tax auditors alone, it’s best to engage an experienced and knowledgeable tax attorney who can employ strategic moves to achieve the best possible results.

Contact Brotman Law for help through the EDD audit process and for quality representation.

Key takeaways on California EDD audits

An audit notice from the Employment Development Department can cause anxiety for California taxpayers and business owners. The EDD tax audit verifies business owners' compliance with the California Unemployment Insurance Code, and requires a response within 10 days. Taxpayers who disagree with the proposed assessment from the EDD can challenge the agency in court.

Remember to read through the Employment Development Department audit notice and consult tax professionals to understand the process before giving a response. Our experienced tax attorneys here at Brotman Law are knowledgeable in California's tax issues, and are just a call away. Our professionals know the best strategies to achieve the best possible results on your case.


Does EDD audit everyone?

The EDD doesn’t audit all employers, but selects companies to audit based on certain criteria and circumstances. The commission may also send an audit notice for verification if an employee complains of incorrect tax records. Wrongly classifying employees in an organization's tax records may also trigger an EDD audit notice.

How long does an EDD audit take?

The payroll tax audit process takes six months when done correctly. But audit length results differ and depend on cooperation levels and the ability to find necessary information for the auditor. Failure to cooperate and provide necessary documents could make the audit process longer than six months.

What happens if you ignore an EDD audit?

If you ignore an EDD audit notice, you send an uncooperative taxpayer signal. Do not ignore an EDD audit notice, as it will cost you considerable money and time. Remember that this audit will not just go away; without legal representation, you may end up with hefty penalties and fines.

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