edd can audit small businesses back 12 quarters

Employment Development Department (EDD) performs many services, but their primary role that impacts small businesses is collecting and auditing payroll taxes. Employers pay payroll taxes for W-2 employees, but not for 1099 independent contractors. 

The line between an independent contractor and an employee was more concretely defined with the implementation of Assembly Bill 5 (AB-5). A worker must meet all three of the following criteria to be classified as an independent contractor: 

  1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work
  2. The worker performs work that is outside the usual course of the hiring entity’s business
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Misclassification mistakes can oftentimes be exactly that – an innocent mistake. However, there are also instances where businesses have taken advantage of classifying employees as independent contractors to avoid paying payroll taxes and investing in employee benefits. This was the case with Dynamex– read the full story here

Purposeful and accidental employee misclassifications strip employees of their benefits and the government of their tax funding. In order to protect both, EDD performs misclassification audits on businesses that are flagged for potential misclassifications. The top 4 EDD audit triggers include

  1. Independent contractors filing for unemployment
  2. Employee complaints to EDD
  3. Late filing of taxes
  4. Randomized verification audits 

If EDD sends you a notice in the mail notifying you they want to audit your business, there is a limit to how far back they can audit. 

 

EDD Audit Statute of Limitations 

The government agency can audit your business EDD can audit your business 12 quarters back from the quarter in which the audit is started, however, audits can go back up to eight years in some cases. 

Watch our full video below to learn more.

 

Only cases involving fraud or intent to evade payroll taxes are not limited by that statute of limitations. In these instances, EDD can audit the business as retroactively as they deem.

Section 1132 of the Unemployment Insurance Code states: 

“Except in the case of failure without good cause to file a return or report, fraud or intent to evade any provision of this division or authorized regulations, every notice of assessment shall be made within three years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued or within three years after the deficient return or report is filed, or was due, whichever period expires the later. An employing unit may waive this limitation period or may consent to its extension.

In case of failure without good cause to file a return or report, every notice of assessment shall be made within eight years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued. An employing unit may waive this limitation period or may consent to its extension.”

 

How Long Do EDD Audits Take?

EDD audits typically last about three to nine months depending on a myriad of factors:

  • How prepared and organized are you for the audit 
  • If they find more information that may need to deepen the investigation 
  • How backlogged the department is

Your auditor will have to review your records, federal income tax return, W-2s, payroll tax returns, 1099 forms, financial statements, and more. They also interview your 1099 independent contractors to cross-verify information. 

The more contractors you have, the longer the audit can potentially take. 

For more information on what to expect during an EDD Audit, read our article here.

 

edd can audit back 3 years

EDD CSLB CFTB Audits

The California Employment Development Department (EDD) conducts audits to determine if businesses are:

  • Correctly classifying their contractors and employees, and
  • Paying the full taxes due under California law

It’s important to note that EDD is actively targeting independent contractor misclassification, which could result in a six-figure penalty per employee for business owners.

Let’s discuss independent contractor classification as well as review some common misconceptions about 1099 workers that can lead to misclassification. Additionally, we’ll cover what to do in the event of an EDD audit.

What is an Independent Contractor?

A 1099 independent contractor is a worker who provides skills and services outside of the hiring business’s usual services. They maintain control of their work and performance, such as:

  • Setting their rates
  • Working with multiple clients
  • Choosing when and where they work
  • Providing their own resources (i.e. tools)

Examples of independent contractors might include electricians, plumbers, carpenters, bricklayers, painters, hair stylists, wedding planners, auto mechanics, florists, and more.

Further, business owners should familiarize themselves with AB-5 law to correctly classify independent contractors and W-2 employees.

What is AB-5 Law?

Assembly Bill 5, commonly referred to as AB-5, is legislation that extends employee classification status to some independent contractors. AB-5 requires that hiring entities reclassify these workers as employees based on the strict criteria outlined in the ABC test.

What is the ABC Test?

The ABC test is a set of requirements a worker must meet to be classified as a 1099 independent contractor instead of a W-2 employee.

The worker must meet all three criteria of the ABC test to be correctly classified as an independent contractor:

  • The worker is free from the control and direction of the hiring entity in connection to the performance of the work.
  • The worker performs work that is outside the usual course of the hiring entity’s business.
  • The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If the employee fails to meet any of the criteria in the ABC test, they are automatically classified as a W-2 employee instead.

Read our Ultimate Guide to Assembly Bill 5 (AB-5) for more information.

Common Misconceptions About Independent Contractors

Misconceptions about independent contractors are common, especially with the addition of the stricter guidelines of AB-5 Law and the ABC test.

Below are some of the most common misconceptions:

  1. Hiring workers as independent contractors are less expensive than hiring them as employees.
  2. If the worker performs similar work for other businesses, they are an independent contractor.
  3. You can hire a worker as an independent contractor on a trial basis before hiring them as a W-2 employee.
  4. Your company can sign a written contract to make the worker an independent contractor.
  5. Your worker has a license so they must be an independent contractor.

Business owners should understand why these misconceptions are inaccurate to correctly classify independent contractors and avoid penalties following an EDD audit.

Read on to learn more about these independent contractor misconceptions.

Which Industries Are More Likely to Misclassify Employees?

According to EDD, industries that run a higher risk of misclassifying workers include: 

  • Construction
  • Hospitality
  • Technology
  • Healthcare, and
  • Seasonal Industries

Business owners in these industries should be aware of the risks associated with employee misclassification and take the time to fully understand AB-5.

How Do Business Owners Correctly Classify Independent Contractors?

Business owners can avoid employee misclassification by reviewing the arrangement they have with the worker concerning the guidelines described in the ABC test and AB-5 law.

What Happens During an EDD Audit?

The EDD conducts tax audits to determine if business owners are meeting their state tax obligations. Typically, they cover the 12 most-recent calendar quarters. Audits, however, may extend further if necessary.

EDD will examine the relationship between the employer and their 1099 worker to determine if the worker is correctly classified.

EDD will ask questions such as:

  • Does the independent contractor have their own business?
  • How does the independent contractor provide services for your company?
  • How much control does the contractor have over providing these services?

As previously discussed, several factors weigh into employee classification. Employers can turn to the ABC test to ensure they are complying with AB-5.

What To Do If You’re Under EDD Investigation

Here are some steps to take if you find out your business is being audited by EDD.

Understand the Type of Audit

Don’t panic – some forms of audits occur with no assumption of wrongdoing or are triggered by random sweeps. The first step you should take when your business is under EDD investigation is to determine the form of the audit.

Verification Audits

Verification audits are not based on an assumption of wrongdoing but are random checks based on factors such as:

  • Business size
  • Size of payroll, or
  • Other factors determined by EDD

Request Audits

Request audits are based upon evidence collected by California EDD from former employees or people closely associated with your business.  

Organize Your Information

Whether you are undergoing a verification audit or request audit, you will need to have specific information prepared for EDD.

Prepare for an audit by organizing the following documents:

  • Cash payment records
  • Verification of ownership
  • Any applicable licenses or written agreements
  • Federal and state tax returns
  • Any 1099 forms
  • General ledger
  • Bank statements for the past three years
  • Check registers
  • Any check stubs or canceled checks
  • Annual financial statements (i.e. balance sheets and expense statements)

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.

Consider Milikowsky Tax Law

Once you are aware your business is being investigated, it’s important to contact a qualified tax attorney to represent you.

At 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.

All employers in California have certain state tax requirements on top of their federal tax obligations.

Read on to understand your EDD obligations as a California employer or to learn more about California EDD audits.

CSLB Site Sweeps

CSLB site sweeps and EDD audits can cost business owners delays, fines, stop-work orders and even potential jail time.

In 2019 and 2020, CSLB’s Statewide Investigative Fraud Team (SWIFT) responded to 855 leads, conducted 52 sting operations and 216 sweep days. These efforts led to the issuance of 260 Notices to Appear in criminal court.  In total, 368 cases resulted in administrative action and 634 cases were referred for criminal prosecution.

However, there are steps business owners can take to mitigate these risks. Let’s dive in.

What is a CSLB Site Sweep?

According to CSLB, construction site inspections, or sweeps, are “among the most effective ways that CSLB ensures contractor compliance with California’s licensing and workers’ compensation (WC) insurance requirements.”

How Do CSLB Site Sweeps Work?

A site sweep occurs when several government agencies, including CSLB, Employment Development Department (EDD), and the California Labor Commissioner target a specific local area. Teams belonging to these government agencies physically visit active sites and conduct a site inspection. These inspections are random and can occur at any time.

During a site inspection, workers are interviewed by CSLB to verify whether they are properly licensed.

What Does CSLB Look For in a Site Sweep?

CSLB will look for:

  • Appropriate licenses
  • Permits
  • Workers’ compensation insurance for employees
  • Adherence to safety rules

What Risks Do General Contractors Face in CSLB Site Sweeps?

If the agency uncovers misclassifications or unlicensed contracted workers, general contractors will be subject to heavy fines and penalties.

Additionally, general contractors who hire unlicensed workers and unlicensed subcontractors put themselves at risk for potential criminal action by the local District Attorney (DA). They risk receiving a stop-work order from CSLB.

Even a legitimate subcontractor who is licensed can run into issues if their license becomes suspended. 

How Can General Contractors Prepare for CSLB Site Sweeps?

General contractors can protect themselves by regularly checking and confirming that all workers’ licenses are current and legitimate. We recommend checking licenses at least on a monthly basis.

CSLB Refers Cases to EDD to Audit

CSLB refers their cases to EDD to audit the company. Let’s take a look at what EDD audits are and the difference between CSLB audits and EDD audits.

What is the Difference Between CSLB Audits and EDD Audits?

Both CSLB and EDD can conduct audits and site sweeps of your business. However, the difference lies in what these agencies are looking for; CSLB focuses on licensing, EDD reviews payroll tax compliance.

To learn more about the difference between these agencies, read our article, here.

What Does EDD Look For in an Audit?

 In an audit,  EDD determines if the employer has paid the full and correct amount of taxes due under California law. Further, EDD identifies whether the independent contractors are correctly classified as 1099 workers or if they should be classified as W-2 employees.

If you are found to have misclassified your workers as 1099s as opposed to wage-earning W-2s, your company is obligated to pay back payroll taxes and will be charged back penalties.

EDD Audits and Employee Misclassification

Employee misclassification can expose your business to fines, penalties, and potential jail time. 

According to EDD, industries that run a higher risk of misclassifying workers include: 

  • Construction 
  • Hospitality 
  • Technology
  • Healthcare
  • Seasonal Industries

Learn more about EDD audits, here.

Facing an EDD Audit?

Once you are aware your business is being investigated, it’s important to reach out to a qualified Tax Attorney to represent you. Crafting the narrative around the “why” and “how” of your contractors’ classification can make the difference between your case being dismissed or your company owing back payroll taxes and fines.

Call Milikowsky Tax Law as soon as you discover your business is facing an audit by CA EDD.

California CPAs should ask their clients who hire 1099s if they have a contractual agreement, invoices, licenses, insurance, and an EIN.

Certified Public Accountants (CPAs) have the most insight into their business owner clients’ daily transactional history. You may find that your clients who have 1099 contractors are now in the grey area of worker classification since it was redefined by AB-5 in January 2020.  

Under the new bill, all workers are automatically classified as W-2 employees unless they meet all three of the following criteria

  1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact
  2. The worker performs work that is outside the usual course of the hiring entity’s business
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

We frequently see cases of inadvertent contractor misclassification that are flagged by The Employment Development Department (EDD). EDD audits are most commonly triggered by: 

  • Independent contractors filing for unemployment benefits 
  • Employee complaints 
  • Late tax filings 
  • Random verification audits 

If the agency finds any misclassified workers during the audit, it results in fines, fees, and penalties that can be damagingly high if left unaddressed. 

Keeping this in mind, here are questions you can ask your clients to ensure that their 1099s are correctly classified, and help your clients reduce the risk of an EDD Misclassification Audit: 

  • Do your 1099s do similar jobs to your W-2s?
  • Do you have a contractor agreement with all of your 1099s?
  • Do your contractors Invoice you?
  • Does your contractor have a license?
  • Do they have insurance? 
  • Do they have an EIN?

Here’s an overview of how each question can provide more insight for your clients. 

Do Your 1099s do Similar Jobs to Your W-2s?

1099 independent contractors who perform similar jobs as W-2 employees may be considered an employee during an audit unless there is a clear distinction between the two. Make sure there are clear distinctions between the two. The W-2 employee works regulated hours, has specific job functions, is provided work equipment, and is told when and how to perform their job duties. They also receive employee benefits and do not have a clear end date for the work performed. 

On the other hand, 1099 independent contractors have flexible working hours, flexible job requirements as dictated through the contract, must provide their own working equipment, can work for multiple employers at the same time, and are not directly managed on job functions. They do not receive employee benefits and have a clearer job end-date. 

For example, one of your business owner clients may have a marketing coordinator who is classified as an employee. Your client may want to hire a marketing agency for a website redesign as a 1099 independent contractor. While both the marketing coordinator and the marketing agency perform job functions under the marketing umbrella, their job functions and classifications are different. 

The coordinator develops and executes the client’s marketing strategy specifically for your client’s company for as long as they work in that specific role. The hired marketing agency will perform the website redesign for your client until the project is complete. Once finished, the partnership is completed. While the marketing agency is working on your client’s website redesign, they can simultaneously work for other companies. 

Do You Have a Contractor Agreement With all of Your 1099s?

The independent contractor agreement outlines specific details for the job the independent contractor will perform. It is the working arrangement between the client and the contractor that typically includes:

  • A description of the job or service provided by the contractor
  • Payment details (this can include information about retainers, deposits and billing) 
  • The length and term of the project or service 

Do Your Contractors Invoice You?

Invoices help keep records of payments, type of work performed, and hours worked. Having organized records of invoices between the contractor and the client helps EDD verify that the independent contractor is indeed an independent contractor. 

Clients who put 1099s on scheduled payroll put themselves at risk for a misclassification audit. W-2 workers should be placed on payroll, not 1099s. 

Does Your Contractor Have a License?

Some workers (such as healthcare professionals and construction workers) are required to provide proper licenses to work. Failing to hire workers with proper licensure can open your client’s business to hefty fines and penalties from EDD. 

If your client hires contractors who don’t have licenses do they have: 

  • A website?
  • A social media presence? 
  • A marketing budget?

These are all important factors to consider. 

Do They Have Insurance? 

Independent contractors provide their own insurance to cover liability, worker’s compensation, or other risks to help them protect their business. If your client is insuring their independent contractors, this is a sign they may actually be W-2 employees. 

Do They Have an EIN?

An EIN is an Employer Identification Number. This is a unique tax identification number for businesses in the United States to pay state and federal taxes. Asking independent contractors without an EIN to provide one is a simple way to further ensure they are 1099s.

All of these factors add up to a robust defense against a misclassification audit by EDD. By fixing any misclassification errors ahead of time, CPAs can save their business owner clients the hefty fines and penalties associated with EDD audit findings. Want to learn more about the EDD audit process? 

Read our article on what to expect in an EDD audit here. 

 

California CPA's should ask their clients the right questions to help them avoid triggering an EDD audit

infographics

California Assembly Bill 5 (AB-5) took effect on January 1, 2020, and is the new standard by which employers must classify employees. Small business owners (SBOs) should familiarize themselves with AB-5 and the ABC test to avoid employee misclassification and potential penalties from the Internal Revenue Service (IRS).

What is Assembly Bill 5 (AB-5)?

Assembly Bill 5, commonly referred to as AB-5, is a piece of legislation that extends employee classification status to some independent contractors, requiring that hiring entities reclassify these workers as employees based on the strict criteria outlined in the ABC Test.

What Caused Assembly Bill 5?

Assembly Bill 5 was inspired by the April 2018 Dynamex Case—when Dynamex reclassified all employees (previously classified as W-2s with all the associated perks) as independent contractors to save employee costs– before being signed into law by Governor Gavin Newsom in September 2019.

Read on to learn how Dynamex ruined it for everyone.

What Businesses Does AB-5 Affect?

AB-5 affects all small businesses and small business owners. Most prominently, AB-5 impacts SBOs who hire 1099 independent contractors and their operations in California.

How Does AB-5 Affect Businesses?

Through AB-5, the California Employment Development Department (EDD) places the burden of proof on businesses to show that workers are correctly classified as 1099 contractors.

The misclassification of employees can lead to:

  • High fines
  • Penalties
  • And back tax payments

How Do I Correctly Classify 1099 Independent Contractors?

AB-5 introduced the ABC test as a stricter guideline to determine how to classify a worker as a 1099 independent contractor. 

What is ABC Test?

Check out our video below for an in-depth explanation of the ABC Test.

The ABC test is a set of requirements that the worker must meet to be classified as a 1099 independent contractor instead of a W-2 employee. The worker must meet all three criteria of the ABC test to be correctly classified as an independent contractor:

  1. The worker is free from the control and direction of the hiring entity in connection to the performance of the work.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If the contractor fails to meet any of the criteria in the ABC test, they are automatically classified as a W-2 employee instead.  

How To Meet The ABC Test Criteria 

When classifying your 1099 independent contractors according to the ABC Test, gather the following information to make sure they are classified correctly.

The First Criteria

  • Gather information on project deliverables and how they are delivered.
  • Have your contractor submit an invoice.
  • Keep correspondence about project timelines recorded in a clear and accurate manner.
  • Ensure you’re not placing requirements on your 1099 contractors regarding how they perform their work. For instance, do not tell the workers what to do or specify reporting requirements. 
  • Document and file scope of work (SOW) from your contractor.

The Second Criteria

  • Compose a definition of your contractors’ line of work.
  • Compose your definition of your business’s line of work (i.e. what products or services does your company provide?)

The Third Criteria

  • Verify if your 1099 has insurance.
  • Ask if they have a legal entity.
  • Check if they have associations, unions, or other affiliations.
  • Review their professional certifications.
  • Gather their business card, website, and a list of other clients the contractor has worked for.

What is the Borello Test?

Before AB-5 was signed into law, the Borello test was used to determine if an employee should be classified as a 1099 independent contractor or a W-2 employee. The Borello test was established by the Supreme Court in S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations (1989). The test relies on 13 factors to determine employee classification.

Even with new AB-5 regulations, the Borello test can still be a useful resource to help classify employees.

EDD provides the full Borello test worksheet with the following questions to help guide classification:

  1. Do you instruct or supervise the person while he or she is working?
  2. Can the worker quit or be discharged (fired) at any time?
  3. Is the work being performed part of your regular business?
  4. Does the worker have a separately established business?
  5. Is the worker free to make business decisions that affect his or her ability to profit from the work?
  6. Does the individual have a substantial investment in their job which would subject him or her to the financial risk of loss?
  7. Do you have employees who do the same type of work?
  8. Do you furnish the tools, equipment, or supplies used to perform the work?
  9. Is the work considered unskilled or semi-skilled labor?
  10. Do you provide training for the worker?
  11. Is the worker paid a fixed salary, an hourly wage, or based on a piece-rate basis?
  12. Did the worker previously perform the same or similar services for you as an employee?
  13. Does the worker believe that he or she is an employee?

Answering “yes” to questions 1-3 would provide a strong indication that the worker is an employee. Answering “no” to questions 4-6 would indicate that a worker is not in business for themselves and would likely classify as an employee. Questions 7-13 indicate important factors to be considered.

While answering “yes” to any one of the questions may indicate that a worker should be classified as an employee, no single factor is enough to determine classification independently.

The full worksheet provided by EDD provides further clarification on certain factors and circumstances.

If completing the provided worksheet does not provide sufficient clarification for employers, EDD also offers the ability to request a written ruling by completing a seven-page form called Determination of Employment Work Status. The form supports any business entity looking to determine if a worker is an employee or an independent contractor.

How Do I Avoid Misclassification?

You can avoid misclassification by carefully analyzing the arrangement you have with your worker in relation to the guidelines described in the ABC test and regulations set forth by AB-5.

To learn more, read on about how to hire an independent contractor.

Independent Contractor

New classification guidelines between W-2 employees and 1099 independent contractors place stricter rules for businesses looking to hire. Common misconceptions about independent contractors can lead to businesses misclassifying workers and paying high penalties and fines. Avoid these consequences by understanding the regulations your business must follow when hiring independent contractors.

Let’s discuss the common misconceptions small businesses have about independent contractors. 

What is an Independent Contractor? 

A 1099 independent contractor is a worker who provides skills and services outside of the hiring entity’s usual course of business. They maintain control of their own work and performance, such as: 

  • Deciding when and where they work
  • Setting their own rates
  • Supporting multiple clients
  • Providing their own tools 
  • And more

How Do You Classify an Independent Contractor?

Worker classification regulations are now stricter due to Assembly Bill 5 (AB-5). This new law took effect in January of 2020 and changed how Small Business Owners (SBOs) who hire Independent Contractors operate in California.  

AB-5 introduced the ABC test as a stricter guideline to determine how to classify a worker as a 1099 independent contractor. The worker must meet all three criteria of the ABC test in order to be classified as a 1099 independent contractor instead of a W-2 employee.

  1. The worker is free from the control and direction of the hiring entity in connection to the performance of the work.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If the contractor misses even one of the criteria in the ABC test, he or she is automatically classified as a W-2 employee. 

Learn more about how this law came into effect, and how Dyanmex ruined it for everyone, here. 

What is the Difference Between a W-2 Employee and a 1099 Independent Contractor?

1099 Independent Contractors

1099 workers have their own independent businesses which the hiring entity maintains little control over – especially regarding daily operations. The hiring entity will not be responsible for withholding taxes from the independent contractor’s paycheck or for providing benefits (i.e. paid time off, medical benefits, and more) to the worker. 

Instead, the worker will usually be paid hourly on a project-to-project basis. The 1099 independent contractor will also often bring their own equipment and supplies to carry out the service. 

W-2 Employees

W-2 employees will be paid on a regular basis, often have a salary instead of hourly income, and may be given certain benefits such as healthcare and vacation pay. The hiring entity is responsible for filling out and filing with state and federal agencies, such as unemployment insurance, worker’s compensation, Medicare and Social Security forms. 

Additionally, the hiring entity is responsible for taking Social Security tax, Medicare and state and federal taxes from the employee’s paycheck as well as supplying any equipment necessary for the employee to perform the service. 

What Are Common Misconceptions About Independent Contractors?

With the addition of stricter guidelines surrounding the classification of W-2 employees and 1099 independent contractors, misconceptions about independent contractors are increasingly prevalent and can often lead to costly mistakes, such as misclassifying a worker. 

1. Hiring Workers as Independent Contractors is Less Expensive than Hiring Them as Employees.

While small businesses may save money on payroll taxes and benefits, hiring an independent contractor on a long-term basis may carry the opposite financial effect.

For example, the lack of control over daily operations and the inability to train workers can hinder the efficiency of the service being performed. These hindrances can lead to the service taking longer, increasing the number of billed hours at which the workers are often paid a higher hourly rate, and result in a higher final cost than if a W-2 employee had provided the service.

2. If the Worker Performs Similar Work for Other Businesses, They Are an Independent Contractor. 

The service performed by the worker is not a determining factor in their classification as a W-2 employee or 1099 independent contractor. 

Instead, the working relationship your company has with this worker, in relation to AB-5 law and the ABC test, will determine their status as an independent contractor. 

3. You Can Hire a Worker as an Independent Contractor on a Trial Basis Before Hiring Them as a W-2 Employee. 

The tradition of hiring a 1099 worker, observing their performance, and switching them over to a W-2 employee after a set trial period is common practice amongst businesses wishing to try out new hires or services. This practice, however, often pushes against the regulations set out by the AB-5 law. 

The working relationship between the new employee and the company during the trial period must be examined in determining their status as an independent contractor.

4. Your Company Can Sign a Written Contract to Make the Worker an Independent Contractor.

A written contract does not necessarily depict an accurate representation of the working relationship between worker and employer. 

The working arrangement must be consistent with the regulations of AB-5 law and the ABC Test for the worker to be classified as an independent contractor, regardless if there is or is not a written contract in place. Further, a contract is not enough to protect the employer from liability for misclassification if the working relationship does not meet the legal requirements for independent contractor status. 

5. Your Worker has a License so They Must be an Independent Contractor. 

Similar to having a contract in place, any licenses the worker has are not enough to determine their classification as an independent contractor. Their status will be determined by a number of factors outlined by AB-5 law and the ABC test.

How Do I Avoid Misclassification?

You can avoid misclassification by carefully analyzing the arrangement you have with your worker in relation to the guidelines described in the ABC test and regulations set forth by AB-5 law.

To learn more, read on about how to hire an independent contractor. 

Right of Control: Who has it and How Does EDD Determine 1099 Status?

When determining whether your workers should be classified as employees or independent contractors, it’s critical to ensure that you are closely following the Employment Development Department’s (EDD) strict guidelines. 

On the simplest level, proper classification is determined by whether or not the principal, or employer, holds the “right of control.”

What is “Right of Control?”

Right of control is determined by who holds the “right to control the manner and means” by which work is performed. 

A corporate administrative assistant, for example, reports directly to an executive who manages their work. Likely they work a classic Monday through Friday, 9 to 5 schedule. When they want to go on vacation, they have to request time off or let their manager know in advance. 

Now consider an app-based rideshare driver. When they’re available to work, they log into the app and begin work. Perhaps after a couple of hours, they decide they need a break, they disable the app and log off for a break. While they are required to abide by the rules and regulations set in place by the company that they work for, their hours and responsibilities are not deliberately determined by the company overall. 

How does EDD determine 1099 status?

EDD utilizes the right of control as an initial way to classify workers. They take things one step further by providing a worksheet that employers can utilize to help clarify discrepancies. 

Since January 2020 the new ABCs of worker classification has been implemented to try to simplify the process of determining worker classification.  Under the ABC test, a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:

  1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Since the passing of the AB_5 gig worker bill, there have been multiple rounds of exceptions, exclusions, and widespread confusion about how the rules affect real-life business scenarios.  In cases of confusion, the original 13 point Borello test is still the fallback. 

The questions posed in the EDD Borello criteria include the following 13 elements to provide additional support in determining workers’ proper classification. They include the following: 

  1. Do you instruct or supervise the person while he or she is working? 
  2. Can the worker quit or be discharged (fired) at any time?
  3. Is the work being performed part of your regular business?
  4. Does the worker have a separately established business?
  5. Is the worker free to make business decisions that affect his or her ability to profit from the work?
  6. Does the individual have a substantial investment in their job which would subject him or her to the financial risk of loss?
  7. Do you have employees who do the same type of work?
  8. Do you furnish the tools, equipment, or supplies used to perform the work?
  9. Is the work considered unskilled or semi-skilled labor?
  10. Do you provide training for the worker?
  11. Is the worker paid a fixed salary, an hourly wage, or based on a piece-rate basis?
  12. Did the worker previously perform the same or similar services for you as an employee?
  13. Does the worker believe that he or she is an employee?

Answering “yes” to questions 1-3 would provide a strong indication that the worker is an employee. Answering “no” to questions 4-6 would indicate that a worker is not in business for themselves and would likely classify as an employee. Questions 7-13 may indicate important factors to be considered. While answering “yes” to any one of them may indicate that a worker should be classified as an employee, no single factor is enough to determine so independently. 

The full worksheet provided by EDD provides further clarification on certain factors and circumstances. If completing the provided worksheet does not provide sufficient clarification for employers, EDD offers the ability to request a written ruling by completing a Determination of Employment Work Status

In cases where EDD initiates a worker classification audit, employers can be required to retroactively prove that their workers were correctly classified at 1099 contractors vs W-2 employees.  At  Milikowsky Tax Law we are experts in EDD audit defense.  Our team works with you to ensure that your audit does not spread to other areas, that EDD understands the scope and function of your unique business and that you are only liable for back fines and fees on those workers who are indisputably misclassified.  

We have represented hundreds of businesses and individuals audited by EDD, CSLB, CFTB, and IRS. Our team is dedicated to ensuring you get the best result and that your audit does not permanently negatively impact your business or your life. Reach out to our team for more information. 

Shot of a young couple sitting on the sofa at home and ignoring each other after a fight

The discovery that a spouse has lied about your shared finances can be devastating. On top of that betrayal, being sent a notice from IRS placing tax burdens on the innocent party can throw even the most financially prepared individual into a state of deep concern.

If IRS should find mistakes or fraud on joint tax returns filed by you and your spouse, legally, both parties are liable for the errors. Situations where one spouse was not aware of their partner’s decisions or behaviors can lead to serious negative financial impact for the innocent spouse. While being involved in all financial statements submitted with your name on them is the best protection, IRS also offer “Innocent Spouse Relief” in cases where your spouse has acted without your knowledge.

Requesting Innocent Spouse Relief

Asking the IRS for relief from a joint tax filing is a complicated process, which begins with filling out an innocent spouse relief form.

You and your tax attorney will need to prove that your spouse acted without your knowledge. This could apply to issues like:

  • Failure to declare income
  • Underreporting income
  • Claiming fraudulent deductions

Once we are able to successfully prove that a tax law error took place without your knowledge, there are three types of relief available, including:

  • Relief from paying interest, tax, and penalties
  • Relief by separation of liability (when taxes and penalties are split between the spouses)
  • Equitable relief in an underpayment or understatement of tax

Get Support for Tax Issues as an Innocent Spouse

While the situation surrounding filing for Innocent Spouse relief can be overwhelming, the team of professionals at Milikowsky Tax Law have years of experience in both tax law and business planning. We can help you to build a compelling case for your right to innocent spouse relief, using our proprietary audit metric technology and our in-depth knowledge of tax law and IRS negotiation.

Our experienced tax lawyers thoroughly research your specific situation and will help you to develop a clear and irrefutable argument for tax relief.

Following your filing for Innocent Spouse Relief, you can rely on the Tax Lawyers at Milikowsky Tax Law to be there to review future filings to ensure that deceptions that lead to the need to file for Innocent Spouse Relief do not recur.

Contact Milikowsky Tax Law today to find out how we can help you submit an innocent spouse relief form and extricate yourself from undeserved tax burdens.

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Meet Milikowsky Tax Law: Your Team of Orange County Tax Attorneys

The highly experienced team at Milikowsky Tax Law is ready to support businesses and business owners in Orange County. We have over 10 years of audit experience representing companies and their owners before IRS and California tax agencies.

Many of our legal professionals are experienced business owners and decision makers themselves. This means we understand the complexity of tax law in Orange County and the nuances of filing taxes in California — we also know firsthand what it takes to protect and grow a company. That means you can take care of running your business and we’ll take care of defending it.

We combine extensive knowledge of tax law in Orange County with unique audit metric technology that applies sophisticated analytics to each IRS or State of California EDD audit. With our help, an investigation doesn’t have to mean the end of your business.

Navigating Tax Law in Orange County

Whether you have questions about the California tax code, or you need to defend yourself against an audit or criminal investigation, Milikowsky Tax Law is here for you.

We have extensive experience developing legal theories and appeals related to payroll tax, income tax, and sales tax matters in civil and criminal cases. Our services include:

  • Helping you understand the complexities of your tax returns
  • Analyzing your tax returns to minimize potential errors
  • Supporting you through an Orange County EDD audit
  • Representing you in the case of California state or IRS investigations
  • Ensuring that your business can run smoothly during and after an investigation

What’s more, the first meeting you have with your Orange County tax attorney will be completely free of charge.

Don’t let the tax law in Orange County threaten your business or add extra stress to your busy life. Enjoy the confidence and peace of mind that comes with having an experienced local attorney by your side. Contact Milikowsky Tax Law now to schedule your free first meeting.

Make sure you provide the list of employees, by wage category, including their wages and their job description with the corresponding code description.

We partnered with benchmark commercial insurance to discuss how audits relate to workers’ compensation. Benchmark offers a boutique approach to serving their clients through providing and maintaining commercial and personal insurance policies. Their goal is to establish comprehensive risk management and accident-avoidance programs to help prevent claims from arising. Get to know benchmark here

Watch our full video on how audits and workers’ compensation relate to one other in our video below.

 

 

How do Audits Relate to Workers’ Compensation?

Under a workers’ compensation policy, a policyholder is required to verify with the workers’ compensation carrier the actual wages that were paid to W-2 employees. In cases of hiring 1099 independent contractors, if they do not have workers’ compensation, the policyholder must verify the policy term. 

Most often, the audits triggered by workers’ compensation issues are referred to as wage verification protocol. The most important thing to remember about wage verification protocol when it comes to a workers’ compensation carrier, is making sure that you are providing the list of employees, by wage category, including their wages and their job description. In the provided list, make sure that each job description matches the code description in which you have them classified. 

During the process, your attorney should be reviewing the schedule with you before submitting the verification to the agent (auditor). Reviewing the schedule helps avoid having to reclassify wages in a higher-rated code post wage verification protocol. 

 

What is the wage verification protocol?

When the Employment Development Department (EDD) notifies business owners of the verification protocol, they send a letter in the mail. When business owners partner with our Milikowsky Tax Law team, we research the hired independent contractors that meet the criteria to be correctly classified as 1099 workers. In this process, we find:

  • Business reports 
  • Background reports 
  • Verify EAM and DBA
  • Business license 
  • EIN number
  • Social media accounts 
  • Website, if they have one (sometimes freelancers use Fiverr or Yelp pages instead)

Sometimes, during the verification process, EDD will notify business owners that workers were misclassified as independent contractors and should actually be classified as full-time W-2 employees. All of the information we gather on each individual worker helps build a case with EDD that the hired 1099 independent contractor is properly classified as such. 

The writeup we create for each worker is included in our initial response to EDD. When the auditor receives it, they don’t have to pursue the same research we already completed. While they will still need to verify our findings, the auditor will not have to develop their own theory about classification because we’ve already given them the story and the answer. This process is easier for the auditor to see versus when they are given information without a story behind it. 

There are tips and tricks to help business owners avoid feeling blindsided through the audit process either by EDD, CSLB, or by their workers’ compensation carrier. We’re here to help before business owners ever get to that process. Learn more about What to Expect in an EDD Audit here.

 

We partnered with benchmark commercial insurance to discuss how audits relate to workers’ compensation.