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The Employment Development Department (EDD) Audit

The Employment Development Department (EDD) Audit 

With the dire impacts of COVID, the Employment Development Department, or EDD, has provided much economic relief and a multitude of support services to people throughout California.  People who have lost their jobs, had their working hours cut, or had their businesses affected due to the pandemic found a haven through the unemployment claims sent to and paid from the EDD.  

In addition, the EDD is one of the largest departments in the state and is responsible for administering the payroll tax regulations for California businesses and individuals.  Likewise, most business owners are very aware of the constant menace of an EDD audit request.  In particular, EDD audit notices are now surfacing due to the obstructed unemployment claims filed by 1099 contractors, and there were a whole lot of them due to the impact of COVID.   

Once a 1099 contractor files for unemployment insurance, an immediate red flag is raised on the business associated with the claim because a contractor is not eligible for unemployment. Even if the applicant was simply unaware of the ineligibility, your business can be entering hot water because the EDD usually takes unemployment claims as a sign that the 1099 contractor may be an incorrectly classified worker. 

AB5 Law Explained

The AB5 law is often referred to as the gig worker law, and it is how a person is defined as either a W2 employee or an independent contractor in the state of California.  Businesses and HR professionals are often left wondering if they are being compliant with the many nuances of this new law, which is the key way to stay out of EDD audit trouble.  Under AB5, workers in California are assumed to be W2 employees and therefore are eligible for benefits like overtime pay, breaks, the right to minimum wage, healthcare, retirement, unemployment insurance and more, while 1099 contractors are not. 

To classify a worker as an 1099 contractor, employers must apply the ABC test and determine that all 3 qualifications found in the test are present.  It can be very tricky to get this determination right, and so to ensure proper compliance, securing the guidance of a tax attorney is your best bet.  Here are the 3 criteria:

A: The worker is free from the control and direction of the hiring entity in connection with the work’s performance, both under the contract for the performance of the work and in fact.

B: The worker performs work that is outside the usual course of the hiring entity’s business.

C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The AB5 law is complex and hard to understand.  Phrases such as “free from control” and “usual course of hiring entity’s business” can be difficult to decipher.  EDD is strictly interpreting the third element, requiring that a contractor work with multiple businesses performing the exact same services for which a hiring entity issues a 1099.  In addition, the law has seen a lot of scrutiny, criticism and change in its short life.  California legislators have introduced multiple amendments and exemptions to the law, while there are still ongoing fights in the courts with some well-known gig economy companies seeking to revise the way classification occurs.  

Avoiding an EDD Audit

Businesses that cannot unequivocally determine that all 3 factors of the ABC test are met by workers, must classify workers as W2 employees in order to stay compliant with this established law.  Once a business has misclassified an employee as an 1099 contractor – whether intentionally or not – you may be at risk of an audit and penalties from EDD.  

There are other triggers that bring on these audits including, most recently, 1099 contractors filing for unemployment benefits.  Others include direct employee complaints for whatever reasons to the EDD or the late filing of payroll taxes/quarterly reports.  Finally, the EDD may just randomly pick your business for an audit.

Whether you unintentionally did something wrong or your business was randomly chosen to get audited, your best bet is to seek legal advice from a seasoned and discerning tax attorney.  Dallo Law Group has an experienced team of CPAs and attorneys that specialize in this very area of California law.  We can help you during the audit process by organizing your forms, records, and financial statements to get you smoothly through.  We can also help you avoid the pitfalls that trigger an EDD audit in the first place and ensure you are compliant from the get go.  

Dallo Law Group can be easily reached and we are happy to screen out any potential mistakes before they become a major issue for your company.  Give us a call:  619-795-8000 for a free case evaluation.