All employers in California have certain state tax requirements on top of their federal tax obligations. Read on to learn more about these requirements, including how they can affect your business and what happens in the case of an Employment Development Department (EDD) audit.
Categories of California State Taxes
California state taxes for businesses fall into four categories:
- Unemployment insurance (UI)
- Employment training (ETT)
- State disability insurance (SDI)
- Personal income tax (PIT)
The first two are the responsibility of the employer to pay, while the latter two are to be withheld from employee wages. It is always the employer’s responsibility to ensure proper withholding and reporting.
The consequences of failing to do so could result in an audit from EDD.
An employer is any business entity or domestic service provider, including:
- Sole proprietorships
- Joint ventures
- Estates, and
Answers to more specific questions about tax applicability can be found on the EDD’s FAQ page.
When you pay wages as an employer, you must ensure that all four payroll taxes administered by the EDD are applied. SDI and PIT should be withheld from employees’ wages alongside federal payroll taxes like Social Security and Medicare; UI and ETT are employer-only contributions.
State Disability Insurance (SDI) Tax
The state disability insurance (SDI) program provides temporary benefits to those with non-work-related disabilities and those who take paid family leave to care for newborns or seriously ill family members.
SDI is deducted from employee wages; the most recent rate is 0.9% of the first $110,902 in wages each year. The maximum tax is $998.12 per employee per year.
California Personal Income Tax (PIT)
The EDD administers the reporting, collection, and enforcement of the California personal income tax, or individual income tax, levied on all California residents to provide for public services, including parks, roads, schools, and health services. There is no wage limit or maximum tax on the PIT; it is withheld based on each employee’s withholding schedule and W-4. This is the state-level equivalent of the federal income tax levied by the Internal Revenue Service (IRS).
Unemployment Insurance (UI) Tax
This program assists individuals who are unemployed through no fault of their own. The unemployment fund is paid into by employers as a percentage of the first $7,000 in wages paid to every employee each calendar year.
Unemployment insurance (UI) rates and amount of taxable wages are determined annually, and the EDD notifies employers of the rate each December. New employers begin by paying a rate of 3.4%; it can eventually rise as high as 6.2%.
Regardless of the rate, the maximum tax is $434 per employee per year.
Employment Training Tax (ETT)
To improve the competitive qualities of California businesses, the employment training tax (ETT) provides funding for employee training in certain industries. Employers pay 0.1% on the first $7,000 in wages paid to every employee each calendar year, with a maximum tax of $7 per employee per year.
What Happens in an EDD Audit?
The EDD conducts payroll tax audits to ensure that employers meet their state tax obligations. Typically, they cover the 12 most-recent calendar quarters, though audits may extend further if necessary.
There are four types of IRS audits that taxpayers should be prepared to navigate. Each type has different requirements and effective strategies to correctly respond to the audit and resolve the issue.
Read on to learn more about types of EDD audits.
What is the Purpose of an Audit?
An auditor will always conduct an entrance interview to explain why an audit is occurring and to answer any questions you might have. An auditor will ensure that:
- Your business is operating under the correct form of ownership and entity
- All paid individuals have been properly identified as employees or independent contractors
- Any unreported payments for personal services have been correctly documented.
Further, some audits will also verify gross and taxable wages and withheld and reported taxes.
It’s important to note that the EDD is authorized to share its findings with the IRS, meaning a state audit can trigger a federal one, too.
Prepare for an audit by organizing the following documents:
- General ledger
- Bank statements for the past three years
- Check registers
- Any check stubs or canceled checks
- Annual financial statements (like balance sheets and expense statements)
- Cash payment records
- Verification of ownership
- Any applicable licenses or written agreements
- Federal and state tax returns
- Any 1099 forms
To verify payroll, you will also need to prepare payroll records, as well as federal and state tax reports, inclusive of quarterly tax reports, unemployment insurance withholding, and employee withholding. Read on for a full list of forms you need to prepare for an audit.
Discussions, Appeals, and Legal Representation
Once the audit is complete, the auditor will conduct an exit interview to review the findings. Depending on the findings, you may be owed money, owe money to the government, or neither. If you are found to have underpaid and receive an assessment, you have a right to appeal.
Consider Milikowsky Tax Law
Our tax attorneys are former business owners and managers, which gives us incredible insight and experience to understand your business from the inside out and provide relentless, effective representation in all tax matters.
A tax attorney experienced with the nuances of California tax law can help advocate for your best interests. Read on for our ultimate guide to tax law for small business owners.