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The Lead System and Framing an Employment Development Department Audit


In California we have what’s called a lead system where the EDD, the state employment tax agency will get a lead from something, then they will send their auditors out to follow up on a lead. The leads are generated from multiple things. They are generated from unemployment claims, they’re generated from a business that perceives to be issuing overabundance of 1099, they are generated from information they gather from other state agencies, they are generated from internal investigations, and they’re generated from other from other sources.

Depending on the strength of the lead, the auditor may or may not know information about your case ahead of time. The first call on the audit is to figure out exactly what the auditor knows about the case. How much third party information have they gathered and what access to that information do they have. A lot of times what you’re going to find is– or especially early in the process, the auditor hasn’t done the due diligence necessary to really investigate the client’s circumstances. They’re following up on a lead, there’s usually a triggering issue, they’ve been assigned to the case and they have to go through the process of documenting a report and going from there.

If you can identify what that issue is, then you can focus on that issue because that’s going to be your battle point in audit. Consequently, if that issue is not a area of concern then you’re going to want to minimize your other areas of concern by addressing the EDD audit techniques that I’ve just defined for you. You are going to want to really focus in on your area, offer that up as your Trojan horse to the auditor.

There’s no problem with offering an issue that you know there’s no risk but you want to make sure there’s no risk before you offer. Once you understand where the client’s getting picked up. Again, in the initial client consult, we usually get at least a base sense of why the client feels that they are subject to audit and what the any risk factors that they have. Some clients are both perfect peril tax audits, some have parts of lots of issues but basically, they’re going to take your, what background facts that you know and when the auditor says what the magic issue is then you’re going to be able to state your client’s position.

Step one, figure out what the auditor knows about the client. Step two, repeat back what you know about the client to set the framework and the auditors mind for how they run their audit. For example, we have a client who issued an extraordinary amount of 1099s for a business. They have six employees, they happened issue 30 1099s in the year in question. The auditor says, we asked the auditor, “Hey auditor, why did you pick up the client?” They say, “Well, it appears that the client is issuing a large amount of 1099 based on the number of employees they have.”

“Okay. Let me just explain to you. We thought this was going to be an issue ahead of time. I just want you to know that the business in question uses a lot of independent things to help them do their job. They’ve also 1099’d their landlord, they’ve 1099-ing their SEO company, they’re 1099-ing in their bookkeeper. I’ll probably get 1099 at the end of the year. but anyway, that’s why it has nothing to do with their employees or employees of employees.

They’ve got the same six people working in the business that have been working in the business for the last three years. One or two come and go but everything’s pretty fine. But just so you know, we’ve got this 1099 issue addressed. We don’t think there’s going to be any real problems in the audit.” You see what I did there? Is I’ve just set an expectation to the auditor. The auditor now has a fact in their mind. It’s an unverified fact but I’ve already stated a position. I’ve already started crafting a narrative to the auditor.

Assuming that I can present evidence that will back up that narrative, the auditor is going to start to believe that story, the more the auditor believes your story, the deeper they go down the rabbit hole then they’re going to basically mitigate any issues in their own mind without you having to do it for them. This will speed up the pace of your audit, this will get you through your general ledger test a lot quicker.

This will get you through 1099 tests quicker because if the auditor believe your story, just like when you believe things, you just trusted is true and you go from there. After you’ve explained the position, after you’ve set the auditor mind, then you’re going to want to go through the author’s initial document request. Hopefully, you’re going to want to try– Most audit request for three years. Hopefully, you want to try and limit the scope of the document request to one year.