As the largest tax collection agency in California, the Employment Development Department (EDD) is charged with collecting payroll taxes from over 17 million workers every year, accounting for over $31 billion of California’s tax system.
Because of its tremendous responsibility, the EDD cracks down hard on those who fail to file the right forms or make appropriate payroll tax withholdings. When dealing with the EDD, there is little room for small business owners or employers to make a mistake.
How to Reduce Your Risk of an EDD Audit
Properly Classifying Workers is the key to avoiding EDD Audit
Ensuring that all of your workers are classified correctly is one of the strongest ways to reduce your risk of an EDD audit. A large portion of California EDD problems are caused by worker misclassification. It can be confusing for small business owners, especially if you are just starting out, to accurately determine whether a worker is an employee (receiving a W-2) or an independent contractor (receiving a 1099).
San Diego’s Top EDD Audit Attorney
If you are struggling to resolve California EDD problems while trying to keep your small business running, look no further than our team. At Milikowsky Tax Law, we are committed to protecting our clients’ best interests and providing expert legal counsel. We understand that dealing with any government agency, particularly the EDD, can be daunting. Working with one of our San Diego EDD audit attorneys will provide you with the defense you need to protect your business.
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:
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:
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:
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:
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:
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:
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.