There are few things in Southern California businesses that create more worry than a notice of audit by the California Employment Development Department (EDD). The good news is, with some guidance by experienced employment law teams in Orange County and San Diego like those at RJS LAW, companies can get through the audit process with a minimum of trouble. If your business has been selected for audit, here’s what you can expect.
I Follow All Legal Requirements. Why am I being Audited?
The first thing a company needs to determine is what type of audit is being performed. The EDD conducts two different types of audits and knowing how your audit is classified will determine how you prepare.
1. Verification Audit
Verification audits are randomly initiated. It’s important to note that these types of audits are not based on any assumption of wrongdoing or problems. Rather verification audits are based on a random selection of employers or other established selection guidelines.
Among the selection criteria:
• Size of the payroll
• Numbers of workers
• Geographic location
• Type of industry
• Liability within a specified time frame, or
• Any combination of the above*
*Source: California Employment Development Department Tax Audit Guidelines
2. Request Audit
Request Audits are the more serious of the two. Your business has been specifically targeted because of information developed either by EDD investigators or through information provided by outsiders-most typically by employees or former employees.
Once Your Company is Targeted for Audit
The auditor will send a package to you. It should consist of an audit notice, a pre-audit questionnaire and a pre-printed standardized request for records covering a specific audit period.
The auditor may also send you a request to extend the statute of limitations. It’s important that you share any and all correspondence that the EDD sends you with your legal representative and that your legal representative signs the EDD Power of Attorney. In all instances, don’t assume the EDD has also copied your attorney. Many times this won’t happen. This is true even when the audit is completed and the EDD issues its findings.
Once you’ve been notified that your business has been selected for audit, the next step is to begin preparing your records. Proper organization is essential. Being prepared and organized can help you minimize any potential fines and penalties. Here are some areas to concentrate on.
Review Independent Contractor Agreements.
If you employ independent contractors one of the most important steps to take now is to review the terms and conditions of any written agreements your business has with them.
If your business has not entered into written agreements with its independent contractors, now is a good time to make that happen. One important factor that the EDD takes into account when determining whether an employer’s relationship with an individual is that of employer-employee or principal-independent contractor is the belief of the parties as to the nature of the working relationship, which can be evidenced by a written agreement.
There are key provisions that should be included or omitted from such agreements in order to confirm the intention of both parties that the working relationship is not one of employer-employee.
EDD red flags would include terms such as requiring the contractor to work during specific times of day, requiring attendance at company-wide meetings or training sessions, requiring the submission of a time sheet, or prohibiting the contractor from working for others.
Obtain Proper Supporting Documentation.
It can be very helpful during an EDD audit if an employer can prove to the auditor that each independent contractor owns and operates his or her own separate business.
Evidence of this can be a completed Form W-9, a business card, letterhead, an invoice, and/or a copy of a business license for each independent contractor who provides services to your business. While it is possible at times to obtain these documents during the audit process, depending on whether your business still has a relationship with the contractor, it looks much better if you have obtained these items at the beginning of the relationship rather than when needed.
File Quarterly Employment Tax Returns On Time.
Make it a priority to file your employment tax returns before it’s due. Besides it being evidence of poor financial record keeping, you could end up with a tax liability for a quarter that would otherwise have not been included.
Deliver 1099 Forms On-Time.
If, at the end of an audit, the EDD determines that some of your contractors should actually be classified as employees, the EDD will then make an assessment on the amounts paid to those independent contractors. Along with penalties and interest, the assessment will include the four California employment taxes that you would be liable for. Typically, personal income tax is the largest assessment. But if your business has filed and delivered the proper 1099’s to each independent contractor, you may submit a signed declaration of those facts to the EDD, and the EDD will remove that portion of the assessment along with certain related penalties, which may amount to over 50% of the assessment.
Keep Records of Cash Payments.
If your business has made cash payments to any person or entity, be sure to keep accurate records of 1. to whom the cash was paid 2. what services or goods were purchased with the cash 3. when it was paid, 4. where the services were provided or goods delivered 5. a viable reason why cash was used, and 6. how much was paid at any one time.
If cash was paid to an individual and your business cannot adequately substantiate the reason for such cash payment, the EDD will assume the payment was for services and will likely assess payroll taxes on the amount paid.
Meeting With the Auditor
Once your records are in order and you’ve reviewed it with your attorney, the next step is to meet with the auditor to review everything and answer any questions. If your records are in order and your legal representative has gone over everything with you, this part of the process should be relatively stress-free.
Once the auditor has completed the review a final determination will be issued, along with any proposed fines and penalties. You’ll have the chance to review the findings and, along with your attorney, determine whether to accept the findings or appeal.
While an EDD audit sounds stressful, with proper record keeping and experienced legal guidance from employment law experts like the Orange County and San Diego teams at RJS LAW, most companies are able to navigate the EDD audit process with a minimum of problems.
This blog post is not intended as legal advice and should be considered general information only. If you have tax or business related questions or if you have received any types of notices from either the IRS, the California Franchise Tax Board, the California Employment Development Department or the California Bureau of Equalization, contact the tax professionals at RJS LAW today.
Our team constantly stays updated on the latest tax issues and we can help you sort through your options. We have convenient offices in Los Angeles, Orange County and San Diego and we can help. For a free consultation call us at (619) 595-1655.