What Can I expect in an EDD Audit?
The California Employment Development Department, otherwise known as the EDD, is the state taxing agency that deals with employment taxes. The EDD processes state payroll tax returns and monitors tax payroll tax liabilities. The EDD also conducts audits and has a collections department to deal with and collect payroll tax liabilities. There is a lot of information that can be found on the EDD website. Taxpayers can file their payroll tax returns online and make payments online.
The EDD conducts payroll audits and is fairly active. Two main focuses of the EDD are: 1) to exam whether the classification of workers as independent contractors is accurate, and 2) to examine whether a business has workers that are not receiving either a 1099 or a W2.
Before reviewing your records, the EDD auditor will conduct an entrance interview with your designated representative who is typically at tax attorney, to explain the purpose of the audit and the audit process, gather general information about the operation and organization of your business and accounting records, and answer questions. You must answer this questionnaire with a great degree of care.
EDD Worker classification audits: Independent Contractor v. Employee
The EDD will review the type of worker and analyze it based on EDD factors to determine whether it the class of workers should be treated as employees or independent contractors. The EDD has published a guide to determining whether a worker should be classified as an employee. You can find the EDD classification guide here: http://www.edd.ca.gov/pdf_pub_ctr/de38.pdf. The EDD auditor will analyze these factors to determine whether a worker or class of workers should be treated as employees.
EDD examination of cash workers
What if there are cash workers? Businesses sometimes employ workers and pay them without reporting those workers to the state or to the IRS on payroll tax returns. The EDD will use the bank records, check register, general ledger and onsite visits to determine if there are any workers that are paid under the table.
What to expect in an EDD audit
The EDD audit will typically begin with the auditor stating that they are there to help educate the business owners and serve as a resource. But make no mistake that they are there to aggressively pursue the audit to uncover any supposed errors. One of the first things to be aware of is the period under audit. The audit period will tell you which years are under examination and the period for which you will need to obtain documentation.
What documents should I give the EDD auditor?
The EDD auditor may want to meet and review documentation requested. The typical documents that are requested by the EDD are as follows:
- Check Registers, Check Stubs, Canceled Checks, and Bank Statements
- General Ledger and General Journal
- Annual Financial Statements (Income & Expense statements, Balance Sheet, etc.)
- Cash Payments Records (pay out slips and vouchers)
- Ownership Verification
- City Business License
- Board of Equalization Sales Tax License
- Any license required to operate your business, such as a liquor license, California State contractor’s license, etc
- Written Agreements (for example, Partnership Agreement or Articles of Incorporation)
- Federal/State Income Tax Returns
- Form 1099 Series, Federal Information Returns and Worksheets
Whether you have these documents on hand will determine what documents you provide to the auditor. Taxpayers are not required to make a document that they do not have in their possession. Therefore, how you proceed with the document request is very strategic and can have a significant impact on your audit.