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Payroll Tax (EDD) | Employee Misclassification | EDD Audits and Settlements

During a payroll tax audit administered by the Employment Development Department (EDD), an EDD auditor will examine your payroll tax returns and related forms (Forms DE6, DE7, DE34, DE DE542, W-2, 1099, etc.) to determine whether the appropriate amount of payroll taxes have been remitted to the EDD. To do so, the EDD will typically examine your personnel, payroll, and accounting records to attempt to ascertain whether the payroll taxes paid to the EDD were paid on behalf of all employees of your company. It is common that the IRS will examine how independent contractors are classified and paid by you and may attempt to reclassify them as employees, which may result in increased payroll taxes, interest, and penalties.  Thus, the first step in an every EDD audit is for an EDD audit attorney to gain an understanding of the business and worker’s responsibilities so that he can defend against potential employee misclassification.

Typically, an EDD (Employment Development Department) audit begins with a former payee filing an unemployment claim. By doing so, your former worker is asserting that they were an employee at your company and they are entitled to unemployment payments. Rather than fully examine the merits of the individual claim, the EDD will instead examine the status of all independent contractors engaged by your company.  At the beginning of an EDD audit, our EDD attorneys will request copies of the unemployment claim case file (if applicable) so that we can structure the best possible defense against employee misclassification, taxes, and penalties.

These audits start with official correspondence notifying you of the audit and requesting documentation, which includes the pre-audit questionnaire. The questionnaire is designed to elicit admissions and well as give the auditor sufficient information to develop an audit plan. Carefully planning the responses to the questionnaire right at this crucial step can help avoid problems later in the audit.  Although at first glance the questions on the pre-audit questionnaire may seem “basic”, the answers to these questions form the back-bone of the EDD audit and it is imperative that you consult with an EDD attorney before filling out this form. At Dallo Law Group, our EDD lawyers are both tax attorneys and CPAs and will carefully and skilfully execute this form so as to not make any unnecessary admissions that may create impediments to the EDD audit.

An EDD auditor has one goal only: To determine if contractors you hired should be re-classified as employees. Once a determination is made, you will owe substantial penalties for failing to withhold income tax, failing to withhold unemployment insurance, failing to withhold state disability insurance, failing to withhold employment training tax, and failing to report employees for past quarters. Typically, the auditor will make a demand for payment of these past due amounts within 30 days. A 10% penalty will be attached if this large payment cannot be made. Notwithstanding these severe penalties for an adverse determination, the IRS will often adopt the conclusions of an EDD audit and assess employment taxes of their own. An adverse decision can create significant payroll tax liabilities.  Many times, penalties are the driving force in an EDD audit because the penalties can exceed the taxes owed in an EDD audit!  For that reason, it is important that your EDD audit attorney is well versed in dealing with the EDD and arguing against penalties.

EDD AUDIT EMPLOYEE FACTOR TEST

There is no bright line rule to determine if your payees are employees or independent  contractors. Generally speaking, the auditor will be trying to determine if the business owner had “direction and control” over the services performed by the worker. For example, strong evidence of control is the right to discharge at will, without cause. If the auditor cannot determine if the right of direction and control exists, they will switch to “secondary factors” to determine the relationship. Examples of secondary factors include:

1)     The level of instructions given to the worker

2)     Training provided, and whether the worker is required to attend meetings

3)     Whether the workers services are integral to the success of the business

4)     Whether the worker must perform the service personally or may use an agent

5)     Whether assistants to the worker are hired by the payor

6)     Whether the working relationship is recurring

7      Whether the worker must adhere to a set schedule

8)     Whether the worker is retained to a full-time schedule

9)    The extent to which the worker must report to the payor’s premises

10)   The independence of the worker in pursuing tasks or goals

11)   Whether the worker must report regular progress

12)   Whether there is a guarantee of minimum salary, or if profit is guaranteed

13)   Whether employee expenses are reimbursed

14)   Whether tools or work facilities are provided by the payor

15)   Whether the worker solicits business from other payors

16)   Whether the worker performs services for more than one person or firm

17)   Whether ending the relationship is at will or is covered by a contract

18)   Industry practices

19)   The level of technical skill required, and

20)   The understanding of the parties

The sheer subjectivity of this list and the discretion of the auditor to weigh factors unequally can make it difficult to negotiate a fair result. It is precisely because there is no hard rule that you should carefully consider every admission you make. Rest assured any admission made regarding the factors above will weigh against you, leading you closer and closer to an adverse decision.  The EDD will always view these factors in their favor, making it harder to convince that a contractor is not an employee.  Our EDD audit attorneys have argued these factors in wide range of industries and companies and can help defend your EDD audit.

TRUST THE EXPERIENCED OF A SKILLED EDD AUDIT ATTORNEY

Given the amount of tax, interest, and penalties at stake, and the possibility that an EDD audit can lead to investigations by other state agencies of the IRS, it is imperative that you have a skilled EDD audit attorney defend your EDD audit.  At Dallo Law Group, or team of attorneys and CPAs have defended countless companies before the EDD and have represented taxpayers all over the State of California.  Although our firm is headquartered in San Diego, we can request that the EDD audit be transferred to the San Diego local office so that we can work with the EDD auditors whom we have developed relationships and to also minimize your involvement in the stressful process.

Feel free to contact our office for a free consultation to discuss how our EDD audit lawyers can help defend your EDD audit.  As always, conversations with our EDD attorneys are privileged and confidential.