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The Payroll Test in a California Payroll Tax Audit

After the initial interview, the EDD will conduct what they call a payroll test. A payroll test is a verification of the business’s payroll posting system. They make sure that payroll is being reported by the business accurately and properly. What that essentially means is the EDD is going to compare their records to the records of the business. Make sure the payroll journal matches what they have on file.

What they’ll do is part of the initial document request you receive from the state will request the payroll journal. They will pick an employee at random. Then they will check that employee’s W2 for the tax year and verify that with what the state has on file. When I say EDD, it can be– EDD is the Employment Development Department in California. But it could be any state payroll tax agency.

They will match the payroll tax returns and look and go and step further. Make sure that the information that was listed on the payroll tax returns, in California those are DE 9s and DE 9Cs, match the information that was reported on the W2 to the IRS. Then match the information that’s in the payroll journal. The state is doing a multi-step check of the payroll to see if there’s any discrepancy. When they look at the taxable wages for the employee, it’s okay if there is a minor difference. Usually attributable to an accounting error. If you have hourly employees, there might be some discrepancy over the hours, but a difference of more than 5% is really going to create a problem during the payroll test. As a practitioner, you need to go through and cross-reference the payroll journal against the W2s and against the payroll tax returns that were filed both against the state. Screening added discrepancies ahead of time and then presenting that. As long as you present that information, then you’ll pass that payroll test.

They will also look at information that may be required by the Department of Labor, any related filings, and then make sure that all the information that they have in their records has been properly transferred over. If there has been entity switch or if there has been a situation where there’s been a change of ownership in a year. In situations where you’re dealing with either a sole-prop that converts into a corporation or you have a change in ownership.

You’re going to also want to compare the business as it was in the past to the business that it was in the future and make sure that you can explain any differences between the payroll tax reporting or the payroll records in those two things. If you have lose employees or things like that, you’re going to want to make sure that you have those answers lined up before you walk into the audit.

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