What Triggers an EDD Audit?

Employee registry, employee benefits, and independent contractor filing for unemployment benefits can trigger an EDD audit. Typically an independent contractor filing for unemployment will trigger an EDD audit because an independent contractor is not eligible for unemployment benefits, so the worker’s claim triggers the EDD audit to look into the worker’s misclassification as an independent contractor.

According to the state, EDD audits occur when companies wrongly classify their workers. Specifically, when businesses categorize employees as independent contractors instead of employees, the EDD takes notice. Therefore, many companies who work with and hire independent contract workers are familiar with or have experienced EDD audits.

In this article, we will briefly outline the factors that can generate an EDD audit. We will also detail what California business owners should know about their chances of being audited by the EDD.

Example: A company’s employee has been misclassified as an independent contractor, and the person applied for unemployment benefits will trigger an EDD audit.

What Do EDD Audits Mean?

An EDD audit is a process initiated to ensure the proper classification of workers and verifies business owners’ compliance with employment laws. The purpose of the EDD audit process is to protect the integrity of the Unemployment Insurance (UI) Fund and to detect potential fraud. The EDD is known to be an aggressive agency, and they take their duty very seriously. The EDD pays expert attention to independent workers and companies and their payroll taxes. Payroll taxes are meaningful in the state of California and contribute to funding parks, roads, and other public works. Therefore, when a company does not properly pay payroll taxes or misclassifies its workers, the EDD goes on high alert.

In California, audits occur when a company is found liable for unpaid or incomplete payroll taxes. When the EDD audits a company and determines that the business treats its contract workers as employees, they often impose fines and other penalties.

Many company taxpayers wonder how the EDD knows about the inner workings of California’s small businesses. Often, business owners think: how does the EDD decide which company to audit? How do they know if a company is, for example, mislabeling its workers or not paying all of its fair tax shares?

Usually, the EDD begins its audit process when an independent contractor files for unemployment insurance (UI) benefits. Why? The EDD reacts this way because, in California, independent contractors cannot collect UI benefits. Therefore, when the worker files to request these benefits anyway, this action alerts the EDD’s radar, and a “red flag” goes up.

Does the EDD Audit Companies Randomly?

Generally, the EDD does not simply choose a business to audit by chance. However, some audits begin this way, and we will cover those a bit later.

Usually, the EDD finds out that an independent contractor has filed for UI benefits. When this action occurs, the EDD’s gears begin rolling, and a full audit often follows.

How Can California Business Owners Classify Workers Properly?

California companies must abide by the state’s “ABC Test” to categorize their employees. Many businesses work with 1099 independent workers, and the owner should know this specific Test.

The ABC Test is derived from a 2018 Supreme Court Case between Dynamex Operations and Los Angeles’ Supreme Court. The Test dictates that individuals who are to be known as independent contractors should be able to answer the following questions positively:

The employee is free from the company’s direction and control regarding the performance of work duties. This includes work done under the work contract and in real practice.

The individual is involved in a trade known to be both independent and established or a business of this nature, and the work is the same as that performed by the company.

The individual performs duties deemed outside the parameters of the company’s typical business.These questions help California companies understand whether or not the EDD will audit them. If the company owner cannot answer these questions affirmatively, they have misclassified their workers. Specifically, if there is evidence that the taxpayer has categorized their workers as independent contractors and not employees, they may be audited by the EDD.

What Happens When The EDD audits Businesses?

When the EDD audits a company, the company may face the following:

Penalties
Interest on owed
Fines based on unpaid taxes, unreported or wrongfully classified workers, and more
While these penalties are serious, an EDD audit does not always result in fines. However, it is prudent to contact an experienced attorney for help with an ED audit.

If the California EDD is auditing your company, contact our California EDD audit attorney for a free consultation.

How Long Do EED Audits Last For?

The EDD audit process takes six months when completed effectively, but it is wrong to think that your audit will be over in exactly six months. Audit times vary based on the company’s sense of cooperation, offenses or clean record, and the time it takes to locate necessary information. We have seen companies face audits lasting over a year when they fail to adhere to the EDD’s requests and rules. The general rule is to complete every request honestly and promptly and hopes for the best.

How far back do EDD Audits Extend?

Typically, the EDD begins the audit within three years, ending with the most recent business quarter. However, if the company fails to file a return for a period or the EDD discovers that fraud occurred, it can lengthen its audit period up to eight years. In some cases, the EDD can extend the audit period as far as they want.

Does the EDD Communicate With the IRS?

Yes, the EDD works in conjunction with the IRS, as well as this list of agencies and entities:

The State of California Franchise Tax Board
The California State Lottery
The California State Controller

Per usual, the goal of the EDD is to pinpoint whether the company owes debts to the state’s UI program, SDI Program, or any other person or entity.

Contact Nakase Wade for Questions About EDD Audits

When companies first hear that an audit is on the horizon, they often do not know what to expect and possess many questions.

At Nakase Wade, our California business attorneys and corporate lawyers will answer your questions about the impending audit and help your company get through the process easily and successfully. Contact our legal team for a free consultation today.

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