Payroll tax revenue is essential for the sustainability of state government programs. The revenue generated from state payroll taxes is used to help fund schools, parks, road maintenance, and other important public services. Thus, the state puts a tremendous amount of pressure on the Employment Development Department to aggressively pursue collection of payroll taxes.
The Employment Development Department is the largest tax agency in all of California. The department can take very severe action against businesses that fail to pay payroll taxes. If your business is facing payroll tax problems, it’s best to consult a local tax attorney to understand your legal options.
The EDD & Payroll Taxes In California
The Employment Development Department handles a number of government functions, but the department is primarily responsible for collecting and administering payroll taxes. Altogether, the state of California has four types of payroll taxes:
- Unemployment insurance (UI)
- Employment training tax (ETT)
- State disability insurance (SDI)
- Personal income tax (PIT)
The unemployment insurance and employment training taxes are funded via employer contributions while disability insurance and personal income taxes are withheld from employee’s wages. As a general rule, wages are subject to all four taxes. However, there are certain types of employment (like real estate brokers) that are not subject to payroll taxes. A full breakdown of tax treatment by employment type is available via the EDD’s information sheet.
Unemployment Insurance Tax
The state unemployment insurance program is part of a national program to provide temporary financial support for individuals who have lost their job under no fault of their own. To fund the program, tax-rated employers are required to pay a percentage on the first $7,000 in wages paid to each employee every year. Tax rates for the UI tax change on an annual basis. New employers can expect to pay 3.4% for a period of two to three years. The maximum possible tax is $434 per employee per year.
Employment Training Tax
The employment training tax was founded to keep California talent competitive with the rest of the nation. The tax funds are used to train workers in targeted industries to further develop more desirable work skills. Employers can expect to pay .001% per year on the first $7,000 in wages paid to each employee. The maximum possible tax is $7 per employee per year.
State Disability Insurance
State disability insurance provides temporary financial support for workers who have been injured in non-work related-accidents. Paid family leave is also a component of state disability insurance. Tax rates for SDI change on an annual basis, but employers are expected to withhold a certain percentage of the first $118,371 in wages paid to each employee every year. The current tax rate is 1%. The maximum possible tax is $1,183.71 per employee per year.
Personal Income Tax
California’s personal income tax is levied on workers (both in and out of state) who earn an income in California. The state offers two methods employers can use to determine how much to withhold from wages and salaries:
Personal income tax is withheld based on the Employee’s Withholding Allowance Certificate (W-4 or DE 4).
Types of Payroll Tax Issues
There are several ways payroll tax issues could arise. The most common problem with payroll taxes is the misclassification of employees as independent contractors. Businesses are not required to withhold payroll taxes for independent contractors. However, workers classified as independent contractors may be considered employees by the state. The Employment Development Department will analyze what degree of control the employer has over the manner, mode, method, and means of work to determine proper classification.
Payroll tax issues may also arise if a company does not have the funds to pay the tax or an incompetent or dishonest employee fails to pay the tax debt. The EDD can take far-reaching and severe actions against a business if payroll tax issues are discovered.
California EDD Audits
Every EDD audit begins with a mailed notification. The notification will often include a list of documents the auditor wishes to review. Commonly requested documents include:
- W-2s and W-4s
- 1099-MISC forms
- General ledgers
- State income tax returns
- City business license
- A sample copy of the company’s independent contractor agreement template
- Samples of invoices submitted by independent contractors
- Forms DE-9 and DE-9C
The primary concern of the auditor in an EDD audit is determining whether or not anyone performing work for the company has been misclassified. The auditor’s main focus will be examining a specific three-year period of payroll taxes. If the auditor finds evidence calling for an expansion in the scope of the audit, the audit could be expanded past three years.
Results will be obtained at the end of the audit. The EDD may conclude that there has been an overpayment or underpayment of taxes. Alternatively, the EDD may also conclude that no difference has been found. If a business is found to have underpaid in taxes, the EDD will demand payment with additional interest and penalties. If payment is not made within 30 days, an additional 10% penalty can be assessed.
Unpaid payroll tax matters should not be taken lightly. The EDD will aggressively pursue payment. They may levy bank accounts, file liens, and seize assets. The EDD has also been known to partner with other state agencies to initiate joint compliance checks resulting in heavy fines and assessments. It’s never advised to initiate contact with the EDD over an EDD audit without first consulting a tax attorney.
RJS Law Is Here To Help
If you are facing payroll tax issues or an impending audit, the tax attorneys at RJS Law can help. Taxpayers who are unfamiliar with state tax policies and procedures may accidentally expose themselves to additional liability. Our attorneys can work with you to achieve the best possible outcome for your case. Call or fill out an online contact form to schedule a complimentary case evaluation.
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