All employers in California have certain state tax requirements on top of their federal tax obligations. California state taxes for businesses fall into four categories: unemployment insurance (UI), employment training (ETT), state disability insurance (SDI) and personal income (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 the Employment Development Department, or EDD.
Employer Designation
An employer is any business entity or domestic service provider, including sole proprietorships, partnerships, joint ventures, corporations, estates, non-profits, and others. Upon paying any non-household worker $100 or more or any household worker $750 or more in a calendar quarter, you become an employer and must register with the EDD within 15 days of payment.
Answers to more specific questions about tax applicability can be found on the EDD’s FAQ page.
Tax Descriptions
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 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 percent of the first $110,902 in wages in 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 this 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 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. 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 percent; it can eventually rise as high as 6.2 percent. Regardless of rate, the maximum tax is $434 per employee per year.
Employment Training Tax (ETT)
To improve the competitive qualities of California businesses, the ETT provides funding for employee training in certain industries. Employers pay 0.1 percent 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.
It is likely in your best interest to speak with a tax attorney if your business comes under audit.
An Audit’s Purpose
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, that all paid individuals have been properly identified as employees or independent contractors, and that any unreported payments for personal services have been correctly documented. More complete 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 that a state audit can trigger a federal one, too.
Preparing Paperwork
Prepare for an audit by organizing the following documents: your 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, and 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. A full list of forms can be found here.
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.
A tax attorney experienced with the nuances of California tax law can help advocate for your best interests. For a free consultation, contact Milikowsky Tax Law today.
