EDD Tax Audits

California Payroll Tax Problem Resolution – Dealing with an EDD Tax Audit

The Employment Development Department is authorized, under the California Unemployment Insurance Code, to conduct payroll tax audits on any business operating in the state. If you’ve received an audit notice, it’s a good time to reach out to a tax professional to assist you in handling the process and understanding all of your options.

Here are the Basics:

First, it’s helpful to know what to expect. Audits by the EDD usually review a three-year timeframe, including the most recent twelve months. For cases in which no returns were filed, this can include more years.

There is an “entrance interview” conducted to explain the audit purpose and process. At this time, the auditor will also ask questions of you or your authorized representative to understand your organization, business, and recordkeeping practices. This also affords you the chance to ask questions of the auditor.

You’ll be asked to provide the auditor with access to your accounting records for the years included in the EDD audit. The auditor will review them to determine several things:

  • Confirm the type of business – partnership, corporation, sole proprietor, other
  • Verify the business ownership
  • Determine whether or not the individuals paid for services were correctly classified, as employees or independent contractors, in accordance with the CUIC definitions and the Supreme Court’s common law test
  • For any unreported payments made for personal services, the auditor will discuss the scope of the working relationship with both you and the worker to determine whether these workers should be classified as contractors or employees.

Additionally, you should be prepared to undergo a series of “tests” for the auditor to ascertain whether or not your company has paid the correct tax amount for the years under scrutiny. These include:

  • Verifying that your company’s gross wages and taxable wages have been properly reported.
  • Confirming that the correct personal income tax and withholding were reported for your employees.
Required Documents and Records

In an EDD tax audit, you will be required to supply the auditor with the following records, at a minimum:

Sections 1085 and 1092 of the CUIC require all employing units to make business records available to the EDD during normal business hours. These records include:

  • 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 Verifi cation - 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

The following, additional records may be required for verification of acknowledged payroll in some cases:

  • Payroll records such as Payroll Journal, Individual Earnings Records,
  • Payroll Summaries, etc.
  • Federal Employment Tax Reports
    • Form W-2, Wage and Tax Statement
    • Form W-4, Employee’s Withholding Allowance Certifi cate
    • Form 941, Employer’s Quarterly Federal Tax Return
    • Form 940, Employer’s Annual Federal Unemployment Tax Return
  • State Employment Tax Reports
    • DE 9, Quarterly Contribution Return and Report of Wages
    • DE 9C, Quarterly Contribution Return and Report of Wages (Continuation)
    • DE 9ADJ, Quarterly Contribution and Wage Adjustment Form
    • DE 6, Quarterly Wage and Withholding Report
    • DE 7, Annual Reconciliation Statement
    • DE 678, Tax and Wage Adjustment Form
    • DE 4, Employee’s Withholding Allowance Certifi cate
Audit Outcomes

At the end of an EDD tax audit, the auditor will want to meet to discuss the findings. This can be as simple as determining that your business is perfectly compliant, resulting in no changes. It can get more complex with overpayments, underpayments, or both. If you’ve overpaid, you’ll be given a tax credit. In the case of underpayments, things can become very complex, resulting in thousands of dollars in newly assessed taxes.

Additionally, the EDD and the IRS have an information exchange agreement. So, if you are assessed additional taxes by the EDD, it can open up implications with the IRS auditors.

You Do Have Options

When you receive an EDD tax audit notice, contacting us can make your life easier. We know the tax code. We can be appointed as a representative to oversee your documentation, working with the auditor to resolve any questions that arise, and in the event of an assessment of additional taxes – work to come up with an effective tax debt resolution.

We handle all of the intricate details of the audit process and negotiation to free you up to do what you do best – run your business.