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Reclassified Payments to Officers in an Employment Development Department Audit

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The auditor is going to look at any payments to officers or any personal expenses that are being written out of the business, and in an effort to classify personal expenses as taxable wages. Let’s talk about that in a little bit of detail. Going back to the officers of the business, and this usually happens when a closely held business with a single owner, or a married couple as an owner, or perhaps two partners that either have a close friendship or have a familial relationship.

In going through the business’s records, they’re going to look for things that are openly flagrant. This is not exactly an income tax audit where they’re going to though and verify the ordinary and necessary purpose of every item. But they are going to look at things that are flagrant like I said and they’re going to go through and try and classify those things. What are things that are flagrant? Meals and entertainment that are considered excessive and or have very low dollar amounts. If your corporate officer has a habit of going to McDonald’s or Wendy’s, and continually charges single order meals through that, unless you can characterize that as a travel meal, then you’re going to run into some problems.

Entertainment is a big category. Any concert tickets, any bars and restaurants, any nightclubs, those types of expenses. Anything that looks like fun, any RV rentals, things like that. That’s what they’re going to look at. They’re going to really scrutinize from a business standpoint. Any grocery expenses, any food expenses, those are obviously very critical to developing a personal– Those are obviously deemed more personal in nature The EDD is going to go back and look at those expenses on an aggregate basis.

What they’re basically looking for, they will ignore isolated instances of smaller categories, but they’re going to look for large-scale evidence that there is commingling involved. Travel is also another big expense that they’re going to look at. If you have a corporate officer who is doing lots of travel to particularly to places that sound like fun, like Las Vegas, Hawaii, places like that, they’re going to look at that. International travel is obviously also very closely scrutinized.

You can’t really change things that occur on the general ledger, nor can you leave out expenses that occur during the course of the business. What you do want to make sure is you have the opportunity to control the document that’s being produced to the auditor. In a lot of times when looking at the general ledger, if you see a lot of these charges that just pop up, you want to make sure that they’re properly classified for what they are.

If they are a travel meal, for example, you want to put them in the travel meal category. If you have a whole bunch of travel meals in a travel meal category, and can explain that the owner of the business has to travel frequently, or is involved in networking, or is involved in whatever, then that as whole looks a lot less flagrant than having a bunch of meals pop up in advertising.

Consequently, if you have meals and entertainment category and you have a lot of low charges, you going to want to make sure you explain those low charges or have an explanation walking the audit. Again, if your general ledger looks organized, if it establishes a presumption of correctness, if everything looks in order, if you walk in there you have a detailed explanation and everything just sounds right, then the auditor’s going to be more willing to accept your explanation.

Again, any absent flagrant circumstances, they’re not going to go back and classify $50 Amazon payment as taxable wages. But they’re going to be looking at large items and they’re going to be looking for a lot of related party payments. They’re also going to be looking at ATM withdrawals and cash payments that can be considered as taxable wages. Make sure you do a good job explaining this to the auditor, and then you can usually mitigate this through the course of an audit.