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How to Defend 1099 Workers in a California Payroll Tax Audit

Number one, is you want to take all the 1099 workers in the business, you want to put them into buckets and determine which buckets are they going to use. Secondly, you want to offer up testimony and/or provide contact information for your best fact pattern within the bucket. We usually take our workers, we usually put them into buckets and then we give them five stars, four stars, three stars. Anything below three stars, we don’t even want to deal with them.

Consequently, if you start having people that you feel less than confident about in a bucket you may just want to go ahead and concede the bucket which will give you some credibility at the audit level. Anyway, what they’re going to be looking for is, they’re going to be looking to look at job categories and they’re going to try to make a determination about the job category so that they can rule for gaps whether the workers are getting it. The more you do, the bullshit of the job category itself, maybe not even the actual independent workers although they will contribute to that you establish in the job category.

The more you do this, I separate the job category and promote its independence, the better off you’re going to be. When building a case prior to going into a payroll tax audit, you’re going to look at your moving parts. You’re going to figure out what your best facts are and you’re going to try and present those facts and minimize your bad facts. Operating under that two-factor test that I just told you. Looking in whether their activities are integral to the business and number two, what the level of control is that the employer really has over that.

After looking at 1099 workers themselves, comparing the 1099s in their buckets to the regular employees in the business and going through that whole process of making a determination on whether a 1099, is, in fact, a 1099 or whether they’re an employee.The EDD is next going to go through the business’s general ledger in detail, the general ledger is important because the general ledger contains a record of all the payments the business made during the audit period in question.

When they go through the general ledger, they’re going to be looking for a couple of different things. Number one, is they’re going to be looking for payments to people. They’re going to be looking for payments to people who may or may not have been a 1099 and they’re going to be looking for payments to the business’s employees and toward 1099 contractors that were not listed on the W2 or the 1099 for whatever reason.

When they go through the general ledger you’re going to be looking at situations where their payments being made to individuals. Then the state is going to put scrutiny on those payments to individuals on a case by case basis.There’s a couple of different things where this process comes up initially. The very first thing it comes up is it comes up with payments to day laborers and just small payments that are being made. For example, a lot of companies will employ janitorial service. Sometimes a janitorial person is just an independent contractor and they’ll just come and clean the office once a week. We write them a $60 cheque every time they come and clean the office.

The state is going to look at those payments and determine whether or not that person is an employee or not. They’re also going to be looking for– In addition to day laborers, they’re going to be looking for payments that may have been reported off the books. Anytime you have a business who is dealing with a high level of, like construction or you’re dealing with a lot of car washes, or restaurants and bars, they’re going to be looking for evidence that there are people that are receiving cash from the business as compensation for services and who are not getting picked up in payroll.

The good thing the general ledger depending on the nature of the business, you should have a clear idea of whether or not this is an issue ahead of time. But make sure that when you do your own review of the general ledger, you go through and are able to explain each payment to any individual in detail. Explain whether or not it’s compensation for services, or whether it’s compensation for something else.