How To Prepare for An EDD Audit

Introduction

Employment Development Department (EDD) audits often create concern for California’s company COOs, CEOs, and CFOs. Many taxpayers and business owners s panic when they notice an audit coming their way from the EDD.

However, much of this panic results from the fact that many taxpayers do not understand the nature of EDD audits, what triggers these audits, or what the process consists of.

Essentially, when the California EDD audits a company, they inspect the taxpayer’s payroll taxes, methods of payment, and financial records. The EDD then makes an assessment based on the materials on hand.

In California, tax authorities also examine tax records to ensure that companies correctly classify their workers. In addition, new regulations mean that California companies who hire independent contractors may have to deal with an EED notice and resulting audit of their company.

We encourage all California companies to ensure they understand the nature of EDD audits because knowledge and understanding will prevent panic and anxiety. Therefore, our EDD audit attorney will cover everything companies need to know about California EDD audits in this article.

Why Do EDD Audits Occur?

EDD audits are relatively common in California’s business world, and when they begin, they initiate a complex process. However, many individuals and businesses wonder what instigates these specific audits.

The following scenarios often cause EDD audits:

• Employees registering for and filing for benefits
• Independent contractors filing for benefits
• Companies filing their taxes later than they are supposed to
• Workers complaining about payments or other grievances
• A company’s failure to pay employees on time
• Randomized verification

How do these scenarios create EDD audits, and what should companies be prepared for when they receive word that an audit will occur?

Let’s look at the answers to these questions as we go over other situations that often warrant an EDD audit in California.

What Are EDD Benefit Audits?

In California, the Employment Development Department (EDD) performs payroll tax audits of businesses.

In part, these processes help protect consumers against fraudulent companies. However, these audits also intend to maintain the efficiency and due diligence of receiving unemployment insurance.

When do EDD Benefit Audits Occur?  EDD benefit audits occur on a three-monthly, daily, and weekly schedule and often successfully detect over-payments of benefits to employees.

Why is the EDD auditing my company?

• Chance Audits

Many companies do not understand what conditions create an EDD benefit audit and see them as “random.” In some cases, they are correct. Sometimes, the EDD randomly selects a taxpayer and then begins an audit. This “surprise” tactic means companies committing fraud do not have time to hide or prevent illicit acts. This method also means that the chances of your company facing a chance EDD benefit audit are not very high. However, it is best to be prepared at all times and ensure that all payment policies and on the level and that the company follows all unemployment benefit regulations and rules for independent contractors.

• EDD Task Force

A task force is a special group that comes together for a uniform purpose. For example, the EDD commission uses its task force to search out problematic employer practices. If an EDD task force notices inconsistent company payments to employees, they might initiate an audit. If the EDD task force notices some questionable benefits payments, they might also trigger an audit.

When the EDD initiates the audit, they send their task force agents to the company to interview workers regarding the company’s actions and their role in the business. Then, based on the employees’ responses and the company’s etiquette, the EDD will decide how to proceed with the audit.

• Workers Compensation Insurance

In some cases, the insurance department reviews workers’ compensation payments made by the company. If a problem is evident, the next step is that the EDD notifies the company regarding a forthcoming audit. In this case, the EDD benefit audit’s purpose is to reorganize payments and reclassify workers into their rightful roles so they receive just payment.

What is an EDD New Worker Registry Audit?

A federal process, the New Employee Registry (NER) audit works with information from the EDD. California companies present their records and information to the EDD, and the process determines if their workers should receive unemployment insurance benefits.

One problem that NER audits intend to confront is that some workers stop working, receive unemployment benefits, and then return to work without reporting their benefits.

What Conditions Create an EDD NER audit?

EDD NER benefit audits often occur when a worker receives UI benefits without reporting those benefits to the IRS. For example, a former California worker applies for UI benefits after being terminated. Next, a company hires the worker as 1099.

This circumstance creates a major misclassification of the worker and often a resulting audit. Since 1099 workers cannot receive unemployment benefits after finishing a job with a company, the commission will update the worker’s classification.

Many believe 1099 employees can receive workers’ compensation, but this is not true. One thousand ninety-nine workers are contractors, as opposed to full-time workers. Often called freelancers or independent contractors, these specialized pieces of the workforce possess multiple clients and their set work hours. These qualities mean that 1099 contract workers cannot collect workers’ comp. Insurance.

• Employee Grievances

Anonymous sources sometimes initiate audits. While this may sound strange, when a random source provides tips about a company’s unfair practices, an audit can follow. This circumstance occurs because the government allows the EDD to explore unauthorized and unknown complaints and grievances.

If the government deems these complaints valid, the next step is to send out a notice of an audit to the offending company.

However, disgruntled former employees sometimes file complaints against companies, even when the company has done nothing wrong. When this occurs, we suggest contacting a skilled, experienced tax lawyer for help with the impending audit.

• Quarterly Payments

An audit often follows when employers report that their employees may have received benefits while working and collecting quarterly pay. In this case, the audit focuses on benefits that employees unjustly receive.

• Crossmatch

The EDD uses an interstate cross-match to determine if workers receive benefits from one state while working in another. The EDD uses new technology to cross-match earnings across different US states yearly. For example, an employee audit ensues if the commission finds that a worker receives benefits from Rhode Island while working in California.

Some companies overpay their employees, which often falls under this audit category. The penalties for these offenses include assorted fines that quickly become substantial, especially when combined.

What is the EDD Audit Process?

To begin the process, the EDD sends an audit notice to the chosen company. Remember, the EDD does not audit individual taxpayers, only companies. Next, several steps occur the interview, a review of documents, possible requests for more information, and an overall assessment by the EDD.

Let’s take a closer look at each of these important steps.

• The EDD Mails a Notice

At the start of this article, we mentioned attempting to allay the panic that the company often feels when an EDD audit begins. Unfortunately, so often, the reception of an alert notice sent by the EDD is the source of this panic.

When an audit is going to happen, companies receive a notice from the EDD regarding the action it plans to take. Taxpayers can reply to the notice, too, if they want to send evidence and documents clarifying their position.

What does the alert notice typically include? Usually, the document provides a list of documents it seeks from the company and a justification for the audit. In addition, the notice often includes a collection of questions to help the individuals and company prepare for the audit.

• The Auditor Interviews the Taxpayer

When the EDD schedules an interview, this often triggers more company-wide panic. The EDD’s entrance interview helps companies understand the audit process and realize why the EDD is auditing them.

The interview occurs between the auditor, the company’s head, or a company representative. Rather than viewing the interview with fear, taxpayers should see the interview as a chance to find out about the audit, speak with agents, and further understand the audit that occurred.

Many companies contact a professional attorney for help preparing their documents and statements for the interview.

• The EDD Collects and Evaluates Documents

Next, the EDD requests documents and evidence from the company. These consist of, but are not limited to:

• 1099s
• Yearly financial statements
• Vouchers
• Pay slips
• Company ownership verification
• Bank statements
• Registries
• Ledgers

While sometimes companies are reticent to provide all of the requested documents, they must know that these articles help the EDD make an informed decision regarding the nature of the audit.

• The Auditor May Ask for Additional Information

After the interview and submission of documents, the EDD often comes back to ask for more information. For example, if the commission notes various inconsistencies in the company’s employment records or payments to workers, they may ask for additional records and means of tracking payroll.

At this point, the EDD may know whether the company’s information is accurate and accounted for or inconsistent. If the EDD believes the taxpayer is hiding information, they may issue a fine.

All companies should be able to submit documents that show how the business deals with firing employees and with worker misconduct.

If, for example, the commission notices that the company made undocumented personal services payments, they will bring this issue to light.

• The Auditor Provides a Notice of Assessment

After the auditor reviews the documents, the commission provides a notice of assessment to taxpayers. Finally, the commission sends the proposed notice of assessment (PNA) or taxpayers so they can read it and possibly request changes.

The audit process differs for every taxpayer and depends on their willingness to cooperate and the company’s actions and offenses. A licensed tax lawyer can help companies identify whether or not they need to worry about an EDD audit.

How do I Fill Out EDD Questionnaire Forms?

Another source of anxiety for many California companies is the pre-audit questionnaire sent by the EDD.

This questionnaire gathers information for auditors. Typically, the document asks questions such as:

• Does the company operate 12 months per year, part-time, seasonally, or something different?

• How would the individual describe the business and its function?

• How many workers does the company employ?

• What worker benefits are provided?

Other questions often follow, intended to provide a working “snapshot of the business.”

• Describe the Company

The pre-audit questionnaire asks taxpayers to describe their companies. This description helps the EDD understand what the business does, whom it employs, and how it functions. This depiction of the company’s business model is important and must be accurate. When companies give the wrong impression during this step, they can be penalized for their inaccuracies.

• Depict the Company’s Services and the Number of Workers

In this step, the EDD wants to understand the company’s employees. For example, how many employees are they, what are they responsible for, and what are their daily duties? This information is vital for the EDD when they examine the company’s classifications of workers, so do not forget this step.

• Provide Bookkeeping Details

The EDD seeks, in this step, to find out more about the various records the company keeps. From staff accounting records to hours worked to payroll information, the audited company must provide accurate, complete information to answer all of the EDD’s questions.

• Provide Employee Benefit Information

Finally, companies must fill out the EDD regarding employees’ tax returns and benefits. If the company gives employees benefits, they must document those benefits for the auditor at this point. Since false or wrong benefits can result in penalties, this step is also essential.

What To Expect At A Meeting with EDD Tax Auditors?

Many taxpayers want to know what to expect about meetings with EDD auditors. While all meetings are different, each auditor follows the same formula, and it is their job to carry out the same duties.

Tax auditors begin by telling the company why they are auditing them. They also will specifically request specific records and documents and provide a timeline for their submission.

Next, the auditor will request financial documents for their perusal. Then, they will assess and verify company ownership and the correct entity type based on the taxpayer’s income tax return. Finally, they will ask about and examine information regarding employee benefits and worker classification.

Finally, the auditor will discuss undocumented payments issued in exchange for personal services if this is an issue. This disclosure will lead to a discussion about employee and company relationships. If any inconsistencies exist regarding workers’ relationship with the business, the auditor will address them. The auditor also asks questions about taxes, including:

• Does the employer withhold and report income taxes properly?
• Did the employer report payroll taxes on earnings for the year properly?

Nakase Wade Can Help

At Nakase Wade, we understand how difficult it is to learn that your company is being audited. Our goal in advising our clients is to help to lessen their anxiety. We will clearly and calmly explain the reasons for California’s EDD audits and tell you what to expect. We will also help your company collect all the necessary documents for a successful audit, so you can move smoothly through the process and continue running a successful business.

When taxpayers deal with EDD auditors without the help of an attorney, they often struggle to understand the terms, concepts, and different phases of the audit while continuing to do business successfully. Our skilled, experienced attorneys will help your company through the audit, so you can continue to succeed.