EDD Audit: What to Do

In California, most business owners are familiar with Employment Development Department audits. Some taxpayers have even experienced an EDD audit and understand why these audits occur and why they are so important.

However, the truth is that many California companies have not had to deal with an EDD audit, and they remain in the dark about what these audits entail and what conditions trigger EDD audits.

This article, our EDD audit lawyer will briefly define EDD audits and explain why they are such an important part of California’s business world. We will also go over what business owners should do when they discover that an EDD audit is headed their way.

What is an EDD Audit in California?

Let’s define the concept for those who remain unclear about the nature of an EDD audit. An EDD audit occurs when the state’s Employment Development Department begins a formal investigation into a company’s payroll practices, dealing with employees, and other operations.

Why does the EDD commence with an EDD audit of a particular company? First, the EDD attempts to determine if California businesses wrongly classify their workers as independent contractors instead of employees. The EDD uses its detailed audit to discover if a company is not paying all its taxes based on its illegitimate classifications.

For example, suppose a company categorizes a worker as an independent contractor, but the company treats them as an employee. In that case, the company does not pay its fair share of taxes. In this scenario, the EDD will audit the company based on suspected wrongdoing, and ultimately the taxpayer and company owner will be penalized.

California taxpayers who hire independent contractors to work for them must pay attention to the rules and regulations enforced by the EDD. When companies ignore the EDD, misclassify their workers, and do not correctly pay their payroll taxes, the EDD will almost certainly audit them at some point.

While these facts may come as welcome advice to some, other California businesses already face an impending audit by the EDD.

In this case, what can the taxpayer do to protect their company, and what should they expect to happen next? In the next section, we’ll answer some of the most commonly asked questions about EDD audits.

What if Businesses Do Not Agree with EDD’s Assessment?

When an EDD audit begins, the EDD sends the company an audit letter, essentially a request for information. The company routinely asks for various documents, including:

• Employment questionnaire form
• Payroll register forms
• Worker register forms
• General ledger register forms
• Wage information

Then, the company sends this information back to the EDD, and the EDD reviews and information and often ask for supplemental information, including documents detailing:

• Employee records
• Payment of payroll taxes
• Records of terminating workers
• Records expressing worker classification

The EDD then sends the proposed notice of assessment (PNA) to the business, and the owner can review it.

If the business owner finds that they do not agree with the decision the EDD makes, they can appeal the assessment. The taxpayer must employ a tax attorney to help with the appeal.

California payroll tax audits quickly become stressful and intimidating, and filing an appeal is no different. Small business owners especially risk losing their livelihoods if they cannot pay the fines from the EDD. Therefore, we encourage all companies being audited to enlist the help of an experienced tax attorney. A skilled lawyer can help create a strong appeal.

However, at this point, the EDD auditor has typically done a careful review of the company and its tax policies and history, and the auditor usually defends their decision. As a result, EDD auditors rarely change their minds based on an appeal. It is still worth filing an appeal, though, if the taxpayer believes the EDD’s information is inaccurate and their judgment is unfair.

What Should Companies Do When the EDD Audits Them?

When California business owners receive word that the EDD is auditing them, their first reaction is typically negative. Running a business is difficult enough, and we’ve never encountered a business owner who enjoys the audit process. For one, the process is time-consuming and normally lasts many months. Also, many businesses find that they are not paying the correct amount of taxes—sometimes through no fault of their own—and that realization means there is more work to do and fines to pay.

However, in some instances, the business is innocent of wrongdoing, and the EDD finds no justification for penalties. For example, if the taxpayer is up to date on taxes and has classified all workers correctly, they should have nothing to worry about.

When the EDD first contacts the business, the business owner should contact an experienced attorney. At this point, the lawyer will help collect and organize the company’s documents. During an EDD audit, the most important resource is company records. Therefore, all companies should keep accurate payroll and tax documents and file their records correctly.

Above all, the key is to try to avoid anxiety and stress. Many companies must go through EDD audits; whatever happens, the goal is to make it through the audit period as quickly and smoothly as possible. Companies should never withhold documents from the EDD or try to play a “waiting game” because the EDD is an aggressive agency that will not stop its search until the audit has concluded and they have the information they want.

What Kind of Records Should Companies Collect for Audits?

Typically, the EDD requests payroll records, financial records, tax returns, employment questionnaires, and worker registers. However, the documents the EDD asks for depending on the particular case’s nature.

After the EDD requests the documents, many companies send the forms and think they’ve finished the process. However, generally, the EDD requests documents numerous times as they follow leads and verify their information. Therefore, do not be surprised if the EDD requests 2-3 sets of documents when the actual audit commences and before they make their decision. Always respond promptly and respectfully to the EDD’s requests, as well.

Is it possible for Companies to Show that Independent Contractors are Not Employees?

Often, the EDD audits California companies because they believe that the business employs independent contractors who are, in actuality, full-time employees.

Some companies, however, seek to show the EDD that their independent contractors are not employees. Is this possible?

Proving this point can be difficult, depending on how the business treats the contractors and their tax and payment records. Proving this concept to the EDD also depends on the type of industry and the work the company is responsible for.

The EDD will investigate all the details, including when the company normally asks the “contractor” to work and if contractors are considered exclusive to the company. For example, if a business requires its independent contractors to attend training sessions and meetings for employees, the EDD may use this information in its assessment.

Chances are, if the EDD audits the company; they already have evidence that the business misclassifies its workers.

What Penalties do EDD Auditors Hand Out?

Companies need to understand what is at stake during an EDD audit. If the EDD’s assessment is negative, taxpayers may face various penalties, including fines. These fines may include the following:

• Unpaid taxes
• Established dollar amounts for cases of unreported workers
• Set dollar amounts for cases of unreported or misclassified contractors
• Additional financial penalties

Realistically, fines and penalties from the EDD can sink a business, especially a smaller company. Therefore, before the audit begins, it is essential that taxpayers contact a lawyer and begin organizing their documents and discussing their defense.

How Can an Experienced EDD Audit Attorney Help?

At Nakase Wade, we have advised enough businesses regarding EDD audits to understand that when an audit occurs, stress follows. Therefore, our skilled tax attorneys and business lawyers aim to help taxpayers understand and get through EDD audits in the best possible way.

EDD audits are typically demanding, time-consuming processes, but if the owners organize and prepare the company, they can deal with auditors successfully and continue when the audit is over. Our legal team helps clients collect and order documents, organize, and get on the same page before the audit begins. Again, thorough preparation is key, so do not wait, contact Nakase Wade today for a free consultation.