Tag Archive for: EDD

how far back irs
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

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

Small business owner responds to EDD audit

Now that the April filing deadline has passed, small business owners may be asking: what’s next?

As tempting as it may be to put off thinking of taxes until next year, some small business owners may be required to respond to an California’s Employment Development Department (EDD) audit.

Read on how to learn common EDD audit triggers and and how to respond.

What is a CA EDD Audit?

EDD conducts an audit to determine if the employer has paid the full and correct amount of taxes due under California law.

What Triggers EDD Audits?

The following circumstances most commonly trigger EDD audits:

  • An independent contractor filing for unemployment
  • The EDD verification process
  • Late filing of tax returns or late payment of taxes
  • Failing to pay wages on time or collect SDI and PIT

Many verification EDD audits are conducted on a random basis. These audits are not based on any assumptions of inaccurate or incomplete information. Additionally, EDD has the power to audit a company if they believe the business has purposefully misclassified workers in an attempt to avoid paying payroll taxes.

However, many legitimate businesses are unintentionally misclassifying employees. Many of these misclassifications are a as a result of new, strict worker classification regulations, related to Assembly Bill 5 (AB-5).

What is AB-5?

AB-5 is a piece of legislation that extends employee classification status to some independent contractors and gig workers depending on the qualifications outlined in the ABC test. AB-5 went into effect on January 1st, 2020, and changed how Small Business Owners (SBOs) who hire independent contractors operate in California.

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

How Can AB-5 Lead to the Misclassification of Employees?

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

  1. Be free from the control and direction of the hiring entity in connection to the performance of the work.
  2. Perform work that is outside the usual course of the hiring entity’s business.
  3. Be 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 one of the criteria in the ABC test, they should be classified as a W-2 employee.

Learn more about AB-5 and the ABC test, here.

What Happens If I Misclassify an Employee?

Employee misclassification can lead to several unfortunate outcomes, including fines and penalties.

With the new regulations, employee misclassification is more common for small businesses. As an example, let’s examine the case study of one of our clients, Ryan Brown, who misclassified his workers and was faced with EDD audit.

Check out the video below!

Meet the Client: Ryan Brown

Ryan Brown owns a construction company in Oceanside, California. His business classified a portion of the staff as 1099 independent contractors and the rest as W-2 employees.

How Can the Misclassification of W-2 Employees Happen?

The services of the hired independent contractor must be consistent with all three of the criteria established by the ABC test or they are automatically classified as a W-2 employee.

In Brown’s case, he didn’t realize that the independent contractors were providing the same services as the W-2 employees. Therefore, the employees he classified as independent contractors didn’t meet the second requirement, “[workers] perform work that is outside of the usual course of the hiring entity’s business.” Thus, all staff members should be classified as W-2 employees–any worker the business claimed was an independent contractor was misclassified.

What Triggered Brown’s EDD Audit?

EDD conducted a random site sweep of Brown’s business. This sweep resulted in EDD finding misclassified workers.

What Happened When Brown Contacted Milikowsky Tax Law?

Brown called Milikowsky Tax Law and set an initial meeting. Before signing any kind of retainer, John started making calls to learn more about the audit and what steps they needed to take immediately to protect the business and provide accurate information to EDD and CSLB.

What Were the Results of Brown’s EDD Audit?

After less than a month, EDD sent a final letter indicating the decision– minor fines were due, the case was closed. For Brown, the results–and knowing his business was going to be fine– provided a sense of relief.

Ryan’s results are both exceptional and the kind of outcome our team strives for with every client. And while we can’t promise any client’s outcome will be the same as another, we can say with utmost assurance that the team at Milikowsky Tax Law is your relentless advocate in the face of EDD, CSLB, and IRS audit.

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. 

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.

A 2021 EDD Audit will include classification criteria from the Borello Test and the ABC Test

Watch our video below to learn how the last 12 quarters affect your EDD audit criteria.

Have You Received an EDD Audit Letter?

The California Employment Development Department (EDD) sends audit letters through the mail. If you receive an audit letter, you have 30 days to reply. Typically, the agency audits back three years from the most recent tax filing. However, EDD sometimes will audit the previous year’s tax filings.

Right now, for example, an EDD audit period would span from 2018 to 2021; the standard 12 quarters (three years time). At this time, that means that your audit process will include the years before AB-5 was signed into law and those years after. EDD audits in 2021 will look different because of the two different verification methods: AB-5 and the Borello test.

What is AB-5?

The law in California named AB-5, effective January 1st 2020, changed the way EDD classifies workers as either W-2 or 1099s. Before January 1st, 2020,  the old rule, the Borello test, was in effect. The Borello test was broader and in the grey zone on who could be classified as a 1099 contractor.

In the case of current California EDD audits, auditors are making determinations on both the old rule for the appropriate time period and on the new ABCs of contractor classification as set forth in AB-5.

Because of this, in some cases, there may be a worker who is classified as an independent contractor under the old rule, and as an employee under the new rule because they don’t meet the more stringent requirements.

According to the California Department of Industrial Relations, workers are employees, not independent contractors unless all of the following requirements are met:

  • “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;
  • 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.”

Under AB-5’s rules, 1099 contractors have to meet all three of the ABC’s of contractor classification to be considered to be a 1099 contractor. If they fail to meet even one classification, they’re automatically classified by EDD as a w-2 employee.

In audits that misclassification is proven, EDD can assess you for payroll taxes and penalties, and interest calculated based upon total payments made.

What is an Unemployment Audit?

Unemployment audits, otherwise known as Unemployment Insurance (UI) benefit audits, are also performed by EDD. The federal-state unemployment insurance system provides temporary wage replacement for those who have lost their jobs. The EDD conducts benefit audits periodically to protect the integrity of the UI program.

These audits aid in lowering employee UI costs. New employees are assigned a 3.4% UI rate for two to three years of employment, which fluctuate after that set time depending on your contribution to UI benefits. EDD can take from 1.5% to 6.2%, but the taxable wage limit caps at $7,000 per calendar year.

EDD benefit audits are conducted on a daily, monthly, and quarterly basis to ensure that UI is distributed to eligible claimants only. They are done by matching the information provided by employers against information provided by individuals who have filed a UI claim.

There are four types of unemployment benefit audits:

  • New employee registry benefit audit
  • National directory of new hires
  • Quarterly wage earnings
  • Interstate crossmatch

If you receive a benefit audit, respond with the completed audit form within 10 days of receiving the notice. For more information on the different types of EDD benefit audits, read our “What is an EDD Benefit Audit?” article.

What Should You Ask Yourself Before an Audit?

Before your company experiences an EDD audit, take the time to go through a profile for your 1099 contractors to ensure they have a legitimate business.

Questions to Ask:

  • Do they have clients?
  • Do they advertise?
  • Do they have their own website?
  • Do they have a business license, tax certificate, or EIN?

For some California cities, if you do business in that city, you’re required to get a business license specific to that location. For instance, if you’re a subcontractor performing work in multiple cities because you have a job that happens to be, for instance, in Del Mar (which is in San Diego and in Riverside), your subcontractors may need to get licenses just to complete that job.

To check the status of your contractor’s license, visit the California Contractors State License Board (CSLB) website. There, you can input your independent contractor’s eight-digit license (located on the contractor’s plastic pocket license), and the website will check if they are licensed under CSLB. The agency will then check the contractor’s:

  • License number
  • Business name
  • Personnel name
  • Home Improvement Salesperson (HIS) number
  • HIS name

Contractors’ licenses can expire or be revoked in the middle of a job so we recommend diligently checking that each contractor has a current license. This will help avoid the fines and penalties of an EDD audit. Click here to learn CSLB’s 10 tips for hiring a licensed contractor.

How Do I Verify My Worker’s Status?

If you are unsure of the correct worker classification there are services that will run independent contractor reports to verify the status of your 1099 hires as legitimate 1099 contractors.  Then you as a business owner can make an informed decision before an audit begins.

If your report uncovers that your workers are misclassified, you can then take the next steps to correctly classify them, or work together with your workers to ensure they then meet the criteria to become a 1099 contractor.

EDD audits are time-consuming and a hassle. Business owners undergoing an EDD audit should be prepared for each step of the process. Read our article on what to expect in an EDD audit for more information.

 

workers must meet all three criteria of the ABC test to be classified as an Independent Contractor

what is the process of an edd audit

If your business is experiencing an EDD audit, it’s important to know what to expect. Founder and managing attorney at Milikowsky Tax Law, John Milikowsky, breaks down the EDD audit process and the frequently asked questions that come with an EDD audit. 

What you can expect from us, whether you have a balance owed to the IRS or the State of California, an EDD audit, or a criminal matter, is a dedicated and passionate team of people who have a lot of expertise to help resolve your issues. Our process is very simple, but it’s very different from many other law firms.”

What is the EDD audit case process at Milikowsky Tax Law?

“We don’t simply submit records to the government. We analyze everything. We use a lot of data analytics to really understand your business. A lot of us, including myself, have run companies before, so we understand what you’re going through. 

We have a lot of business experience. We know exactly what to look for, and we can anticipate the questions the government’s going to ask and we’ll build strategies and defenses in advance.

Once we’ve looked at all your records and identified potential issues, we identify strategies to navigate around them. At that point, we execute on our findings and work toward a resolution for your case.

EDD Audit Step by Step Guide

If you are being audited by EDD, you will receive a letter of inquiry.  Upon receiving this letter, the clock starts counting down.  You have a limited about of time in which to respond.

Our process begins with an interview, in person or over Zoom in which we get a good understanding of your business.

We gather documents to begin to analyze everything.

  • Your accounting records
  • Your transactional documents
  • Interviewing your workers, 
  • Interviewing other business associates

After our internal analysis, we give you a debrief and provide a roadmap of how the case will likely proceed. 

Once we collect and analyze your information, build the narrative around why your contractors are correctly classified and how your business is structured, we begin to communicate with the government. 

Are All Audits the Same?

Whenever an audit is initiated, the audited party will receive a letter from the government requesting records for a “routine investigation”. In the case of EDD audits, the process is usually initiated by a red flag that you have misclassified your workers. Some of the ways the agency can be alerted to this are:

  • A 1099 contractor filed for unemployment
  • A competitor raised a complaint
  • You were subject to a random site sweep by EDD or Contractors State Licensing Board (CSLB)
  • Your payroll records did not match your IRS filings and the agencies communicated.

How is an EDD audit case resolved?

Edd audits require a lot of negotiation and communication because each business is structured differently, workers perform different jobs and the rules from classification have changed even within the 12 quarter audit period as it stands in Q4 of 2021. 

The final resolution comes in the form of a letter from the government that say either there is nothing owed, you owe fees penalties and back taxes or, there was an error in your favor.