Tag Archive for: EDD Audit Risk

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

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.

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Long-term closures caused by COVID-19 have led many companies to make massive cuts, mostly by furloughing or laying off their employees. However, qualified companies have the option to enroll in the EDD Workshare Program, which allows a business to pay full salaries to its workers who have had to reduce their hours due to COVID-19. 

Companies can use the loans provided by the EDD Workshare Program to pay their workers a prorated percentage of their Unemployment Insurance benefits. This seems like a beneficial program for any company that would like to avoid layoffs and maintain the same workforce who have already been trained and will be eager to work once they can. 

However, applying to the Workshare Program could result in an EDD audit, at some point down the road. The California EDD audits companies to ensure that they are adhering to California’s payroll tax laws and are collecting payroll taxes from their employees. The taxes the employer is responsible for include unemployment insurance and employment training tax.

The EDD conducts audits to check if the employer was fully paid the taxes they owe under California law. Because the Workshare Program utilizes the Unemployment Insurance payments, the EDD must ensure that the company has paid the taxes they owe. 

In a case where your company is applying for the Workshare Program, the EDD would likely conduct an audit for verification purposes. This audit would allow the EDD to confirm that you have adhered to the California tax law. 

If you are facing an EDD audit, our best advice is to consult a tax lawyer. We at Milikowsky Tax Law can help! Contact us to see the best way to prepare for an EDD Audit.