Can the EDD assess a Penalty from an Audit?
The EDD can assess some penalties that can be relatively high compared to the tax liability. Consequently, taxpayers often ask their tax attorney what types of penalties could be assessed against them in an EDD audit. However, the good news is that a tax attorney can discuss with you strategies to minimize the tax assessed and penalties assessed.
What is the EDD Personal Income Tax Penalty (PIT Penalty)?
California Unemployment Insurance Code (CUIC) section 13071 provides the relevant language for the personal income tax penalty that can be assessed against the employer. Section 13071 states: “If the employer, in violation of the provisions of this division, fails to deduct and withhold the tax under this division, and thereafter the tax against which the tax may be credited is paid or the taxpayer reports to the Franchise Tax Board the wages or gross income against which the tax would have been imposed, the tax so required to be deducted and withheld shall not be collected from the employer, but this section shall in no case relieve the employer from liability for any penalties or additions to the tax otherwise applicable with respect to the failure to deduct and withhold.” You can read the code section here: http://law.onecle.com/california/unemployment-insurance/13071.html.
What does this section mean? In a nutshell, if a 1099 was not issued or if the employer cannot prove that the employee included wages or salary in his or her income, then the employer will be liable for the personal income tax for the employee. What can be done? You should make sure to issue all 1099s to workers. Moreover, if the 1099 is issued, then it is presumed that the worker reported that income to the taxing authorities. Additionally, all workers who receive more than $600 of salary and are not working through a corporation must receive a 1099 if they are classified as an independent contractor. You can find a detailed discussion on the rules for 1099s on our blog article about 1099 filing requirements.
However, if you have not issued 1099s, you can still obtain an affidavit from the workers that they included the payments in income on their personal tax returns. You can abate an EDD PIT penalty through these two options.
EDD Fraud Penalty
In certain circumstances, the EDD can assess a fraud penalty if it believes that the noncompliance was a result of intentional disregard. CUIC Section 1128(a) states:
“(a) If any employing unit fails to make a return or report as required under this division, the director shall make an estimate based upon any information in his or her possession or that may come into his or her possession of the amount of wages paid for employment in the period or periods for which no return or report was filed and upon the basis of the estimate shall compute and assess the amounts of employer and worker contributions payable by the employing unit, adding thereto a penalty of 15 percent of the amount of contributions.”
Therefore, if the employer fails to file a return or report, or files a deficient return or report, and the EDD auditor believes that any part of the deficiency is due to fraud or intent to evade, a penalty of 50 percent will be added to the assessment. You should attempt to avoid this penalty at all costs. It is important that you are very cautious as to the approach you take when communicating to the EDD auditor so that the auditor doesn’t misinterpret any information that you provide.