EDD Audit Triggers

For any business operating in California, an audit by the Employment Development Department (EDD) can be a significant concern. The EDD is responsible for administering the state’s payroll tax laws, collecting contributions for unemployment insurance (UI), state disability insurance (SDI), employment training tax (ETT), and personal income tax (PIT) withholding. When the EDD initiates an audit, its primary goal is to ensure businesses are in full compliance with these regulations. Understanding the common EDD audit triggers  and how to prepare your business can significantly reduce risk and minimize potential liabilities.

The Purpose of an EDD Audit

An EDD audit is essentially a review of a business’s records to verify workers are properly classified, wages are accurately reported, and all required payroll taxes have been paid on time. The EDD aims to protect workers’ rights to benefits and ensure a level playing field for all businesses by enforcing compliance. While the prospect of an audit can be daunting, it is a routine part of the EDD’s enforcement efforts.

Common Triggers for an EDD Audit

Businesses can find themselves subject to an EDD audit for various reasons, some of which are more common than others. Awareness of these triggers is the first step in prevention.

Independent Contractor Misclassification

This is, by far, one of the most frequent and impactful triggers for an EDD audit. California has stringent rules for classifying workers as independent contractors versus employees, primarily governed by the “ABC Test” and, in certain circumstances, the “Borello Test.” If a worker was paid as an independent contractor and later files for unemployment benefits, it triggers a signal to the EDD of potential employee  misclassification issues.

The EDD views independent contractors as generally ineligible for unemployment benefits. When such a claim is filed, it prompts an investigation into the nature of the worker’s relationship with the business. If the EDD determines the worker should have been classified as an employee, the business could face significant back taxes, penalties, and interest for all misclassified workers, potentially going back several years.

Late Filings and Payments

Consistent late filing of payroll tax returns or delayed payment of taxes is a clear red flag for the EDD. Even minor delays can attract attention, and repeated delinquency significantly increases the likelihood of an audit. The EDD imposes penalties for late payments, which can escalate quickly, so timely compliance is crucial.

Employee Complaints

Disgruntled current or former employees can trigger an EDD audit by filing complaints. These complaints can range from alleged unpaid wages, disputes over benefits, to claims of misclassification. The EDD is authorized to investigate such complaints, and they often lead directly to an audit.

Discrepancies in Reported Wages or Taxes

The EDD routinely cross-references data with other government agencies, such as the Internal Revenue Service (IRS) and the Workers’ Compensation Insurance Rating Bureau. If inconsistencies are found between the wages and taxes reported to the EDD and those reported to other agencies, it can trigger a crossmatch audit. Similarly, internal discrepancies within a business’s own EDD filings can also raise suspicion.

Random Selection

While less common than specific triggers, the EDD does conduct random “verification audits” as part of its general compliance efforts. These audits are not initiated by a specific event or allegation but are part of the EDD’s strategy to ensure overall adherence to payroll tax laws.

Proactive Steps to Prepare for an Audit

Preparation is key to navigating an EDD audit successfully and mitigating potential liabilities.

Conduct Regular Internal Audits of Worker Classification

Given the prevalence of independent contractor misclassification as an audit trigger, businesses should proactively review their worker classification practices. This involves carefully assessing each independent contractor relationship against both the “ABC”  and “Borello” test criteria. If a worker fails any part of this test, they are generally presumed to be an employee. Seeking legal counsel to perform an internal review can help identify and correct potential misclassifications before the EDD does.

Maintain Meticulous Records

Organized and complete records are indispensable during an EDD audit. Businesses should retain comprehensive payroll records, employee contracts, independent contractor agreements, timekeeping data, payment documentation, and any other relevant financial records. The EDD typically requests records for the past three years, but in cases of suspected fraud or unfiled returns, this period can extend further. Having readily accessible and accurate documentation demonstrates diligence and can significantly streamline the audit process.

Ensure Timely Filings and Payments

Adhering to all EDD filing and payment deadlines is fundamental. Businesses should establish robust internal processes to ensure all required forms are submitted, and all taxes are paid on time. This includes quarterly payroll tax returns (DE 9 and DE 9C) and annual information returns (e.g., Form 1099-NEC for independent contractors).

Understand EDD Communications

Do not ignore any notices or correspondence from the EDD. These communications often contain important information, including audit notifications, requests for information, or proposed assessments. Businesses should promptly review these documents and understand what is being requested or communicated.

Seek Expert Counsel | EDD Audit Triggers

Perhaps the most critical step in preparing for and responding to an EDD audit is to engage with a California tax attorney experienced in EDD matters. Legal representation can provide invaluable guidance throughout the process, from the initial audit notification to potential appeals. A qualified, experienced tax attorney can help interpret complex regulations, assist in gathering and presenting documentation, communicate with the auditor on the business’s behalf, and work to protect the business’s interests and minimize potential liabilities. Attempting to navigate an EDD audit without professional guidance can lead to costly errors and missed opportunities to challenge findings.

Conclusion | EDD Audit Triggers

California EDD audits are a reality for businesses, and the consequences of non-compliance can be severe. By understanding the common audit triggers and implementing proactive measures, especially regarding worker classification and meticulous recordkeeping, businesses can significantly reduce their exposure. Should an audit notice arrive, seeking the guidance of an experienced California tax attorney is a crucial step to ensure the business’s rights are protected and the audit process is navigated effectively. Proactive preparation and informed response are the strongest defenses against the financial and operational disruptions an EDD audit can cause.

The experienced Tax Attorneys at RJS Law have years of combined experience in dealing with Employment Development Department (EDD) audits as well as audits originated by other state and federal agencies.  For a no-cost consultation, please contact RJS LAW on the web or call 619-595-1655.