For most small business owners, receiving a payroll tax audit notice is an anxiety-inducing event that makes you question every contractor agreement and expense report. That’s exactly what happened to Donna Simcoe, the owner of Simcoe Consultants, when she opened her mail to find an Employment Development Department (EDD) audit notice waiting for her.
What began as a moment of panic turned into a story of triumph. Donna worked with us to handle her payroll tax audit and passed with flying colors. In this video, we unpack Donna’s journey, the strategies that worked for her, and the lessons every business owner can take away to prepare for—and even prevent—payroll tax audits.
From Panic to Preparation
Donna Simcoe is a seasoned professional in the medical publications field, running her consultancy with the help of independent contractors, including freelance writers and graphic designers. For years, her business operated smoothly—until the audit notice arrived.
Like most business owners, Donna felt overwhelmed and unsure of what to do next. Turning to her accountant for advice, she was directed to an article on our website. The article—a step-by-step guide to payroll tax audits—resonated with Donna and ultimately led her to book a consultation with Sam Brotman, Managing Attorney at the firm.
From the first meeting, Sam walked Donna through the audit process and assured her that with the right preparation, she could handle the situation confidently.
Worker Classification: A Tricky Balancing Act
One of the key concerns in Donna’s case, and a central focus of many payroll tax audits, was worker classification.
- For workers, misclassification can mean losing out on tax benefits like deductions for business expenses.
- For employers, the stakes are even higher: misclassification can result in back taxes, penalties, and compliance headaches.
Carlos Gomez, Senior Associate Attorney at Brotman Law, joined the case to help Donna navigate this tricky area. Carlos explained that laws like California’s AB5 are designed to protect workers from being unfairly classified as independent contractors. But in practice, these laws often leave business owners scrambling to prove they haven’t done anything wrong.
Auditors frequently approach 1099 forms with suspicion, assuming misclassification until proven otherwise. For Donna, this meant demonstrating that her business acted as the architect of strategy, outsourcing writing and graphic design work. Proving this distinction required meticulous preparation to address the auditor’s concerns.
The Anatomy of a Payroll Tax Audit
If you’ve never been through a payroll tax audit, here’s how it typically plays out:
- The Notice: It all begins with an official letter requesting documents.
- The Review: Auditors comb through the submitted materials, looking for inconsistencies or red flags.
- The Meeting: You (or your legal representative) sit down with the auditor to answer questions and clarify details.
- The Outcome: The audit concludes with one of three results: no changes, a refund, or an assessment of additional taxes and penalties.
For Donna, a no-change audit was the goal—a result that requires thorough preparation, clear documentation, and strategic responses to every question.
How Brotman Law Helped Donna Succeed
Donna’s success wasn’t a matter of luck. It was the result of careful planning and expert execution. Here’s what we did to turn the tide in her favor:
- Pre-Audit Preparation: We created detailed profiles for each of Donna’s contractors to demonstrate why they were classified as independent workers.
- Strategic Positioning: We addressed potential red flags directly, demonstrating that Donna’s consultancy serves as the architect of strategy, outsourcing specific services to independent contractors who were not integral to her core business—a crucial distinction in classification disputes.
By addressing these issues proactively, we set the stage for a smooth audit process.
Lessons for Every Business Owner
Donna’s story isn’t unique. Payroll tax audits are increasingly common, and every business owner can benefit from the lessons she learned:
- Don’t Wait to Seek Help: If you’re unsure about your compliance, consult a professional sooner rather than later. Legal expertise can save you time, money, and stress.
- Review Your Contractor Agreements: Well-drafted agreements can protect you and clarify the nature of your working relationships.
- Stay Educated: Just because others in your industry operate a certain way doesn’t mean it’s legally compliant. Understanding the rules can help you avoid costly mistakes.
The Happy Ending
After a few weeks of preparation and strategic responses to the auditor’s inquiries, Donna’s audit concluded as a no-change audit. She owed no additional taxes or penalties—a testament to the power of thorough documentation and legal support.
Reflecting on her experience, Donna credits Brotman Law for not only resolving her audit but also empowering her with knowledge and confidence in her business practices.
Final Thoughts
Payroll tax audits might seem like an unavoidable storm, but with the right preparation, they don’t have to be catastrophic. Donna’s case shows that proactive measures, legal guidance, and a clear understanding of worker classification can make all the difference.
If you’ve received an audit notice—or want to ensure your business is audit-ready—don’t hesitate to reach out to Brotman Law. We’re here to help you navigate the complexities of compliance and keep your business on solid ground.