EDD Audits Are Expanding. Here’s What California Businesses Need to Know
California businesses are seeing a sharp rise in Employment Development Department (EDD) audits, and one of the most significant changes is the expansion of audit lookback periods. While a standard audit typically covers three years, EDD now has the authority to reach back eight years when independent contractor issues are involved. For companies that work with 1099 workers, this shift carries serious financial implications.
Let’s review what triggers EDD audits, how far back EDD audits can go, what business owners can expect during an EDD audit, and why proper classification of independent contractors is more important than ever.
How Far Back Can an EDD Audit Go?
The standard EDD audit covers the most recent three calendar years. However, EDD can expand the audit to eight years when:
- A business uses independent contractors
- No payroll account was opened with EDD
- A payroll account was opened years after 1099s were first issued
- EDD finds indicators of misclassification or unreported wages
This expanded lookback dramatically increases potential assessments, including payroll taxes, penalties, and interest.
As John Milikowsky explains in the accompanying video, businesses that rely on contractors without maintaining a payroll account are especially vulnerable. EDD views this as evidence that workers may have been misclassified and that payroll taxes should have been withheld.
Why EDD Is Increasing Audit Activity
California has intensified enforcement around worker classification, driven by:
- AB-5 and its strict ABC test
- The Department of Labor’s independent contractor rule
- Increased pressure on agencies to recover lost payroll tax revenue
- Cross-agency data matching between IRS, EDD, and DIR
EDD is focusing on recovering payroll taxes during an economic period where state revenue is under stress. Businesses that rely on contractors in construction, transportation, home services, consulting, and entertainment are being flagged at higher rates.
Common Triggers of an EDD Audit
EDD audits often begin with one of the following:
1. A 1099 Worker Files for Unemployment
If a contractor files an unemployment claim, EDD investigates whether the worker was misclassified.
2. A Worker Files a Wage Claim with the Labor Commissioner
Claims for unpaid wages, overtime, or breaks frequently escalate to EDD review.
3. Inconsistent or Missing Payroll Reports
Gaps, late filings, or unusual data patterns may trigger automated review.
4. A Federal Audit or IRS 1099-Mismatches
EDD receives information directly from the IRS. An IRS audit can prompt a related EDD audit.
5. Opening a Payroll Account Late
If 1099s were issued for years before the business opened a payroll account, EDD views this as a red flag.
6. Industry-Specific Enforcement Sweeps
EDD targets industries known for contractor-heavy workforces.
7. Anonymous Tips or Competitor Complaints
EDD investigates every tip, even if the information is inaccurate.
8. Failure to Register as an Employer
If a business pays workers but never created a payroll account, an eight-year audit is likely.
How the ABC Test Influences EDD Findings
EDD applies the AB-5 ABC test to determine whether a worker is a legitimate contractor. A worker is presumed to be an employee unless all three parts of the test are met:
- A. The worker is free from direction and control
B. The worker performs work outside the usual course of the business
C. The worker is independently established in that trade
Part B is where most companies fail. If a contractor performs work that is core to the business, EDD generally classifies them as an employee.
For deeper guidance, Milikowsky Tax Law read our Ultimate Guide to AB-5 and the DOL’s rule on independent contractors.
What Happens During an EDD Audit
Businesses should expect EDD to request:
- Payroll records and bank statements
- General ledger and cash disbursement journals
- 1099s and W-2s
- Proof of independent contractor status such as contracts, licenses, insurance, and invoices
- Details about the nature of each worker’s services
EDD will review payments, interview workers, and determine whether any individuals were misclassified. If EDD believes contractors should have been employees, the agency can assess:
- Back payroll taxes
- Penalties for failure to withhold and remit
- Interest
- Additional penalties for willfulness or fraud
With an eight-year lookback, these amounts can be substantial.
How to Protect Your Business from EDD Audit
The best protection is proactive classification compliance, supported by documentation that shows:
- Contractors operate independently
- Contractors have multiple clients, not only your business
- Work performed is outside the usual course of your business
- Contractors have appropriate licenses, insurance, and business structure
If you are currently under audit or expect one, early legal involvement can shorten the audit, narrow the scope, and reduce the assessment.
When You Should Call Milikowsky Tax Law
If you received an EDD notice, if a contractor filed an unemployment claim, or if you suspect your contractor structure could trigger an audit, reach out to our team, call us at (858) 450-1040. Milikowsky Tax Law has represented hundreds of California companies in EDD, CDTFA, and IRS audits.
We provide a confidential assessment and help you understand your exposure before EDD expands the scope of the audit.
