Been there, done that: dealing with the EDD and FTB.

A couple of things are reasonably well known when it comes to dealing with California's Employment Development Department.

First, the EDD is heavily engaged in attempting to re-categorize workers from independent contractors to employees.

Next, probably more than one-half of EDD audits arise when someone who's been carried as an independent contractor applies for unemployment, SDI or workers' compensation. When the worker files a claim, the EDD responds, 'Funny, we don't have any payroll records for you; we'll look into it.' That's a "gotcha" for the business that's been paying the worker.

Most CPAs tell clients whose workers clearly are employees, but who want to be paid either as independent contractors or "paid in cash," not to touch those arrangements with a 10-foot pole. You can be certain any such individual knows exactly where to find the unemployment, SDI and workers' comp offices if the relationship sours.

During the claims process, EDD interviewers will ask claimants whom they "work for." If the claimant states that they work for Company X, then the gotcha process continues. If the claimant says that they are in business for themselves, then the process ends because the claimant isn't an employee. This is a bit of semantics, because some CPAs in public practice say that they "work for" their clients, but the point is clear.

Another listserve participant shares an EDD tale in which a client received a pre-audit questionnaire, completed and returned it. The EDD responded that it would pass on an audit. However, the EDD sent a second questionnaire with different questions, with the obvious intent that perhaps new responses would provide grounds for an audit.

Apparently, EDD gets data from FTB and IRS indicating if payments reported on a 1099 show up on the payee's Schedule C. It's an EDD audit indicator. Form 1099 payments that don't show up on a Schedule C do result in an IRS CP-2000 notice to the payee and a parallel FTB notice.

How Do You Deal With an FTB Notice That Your Client's Tax Balance Due Hasn't Been Paid?

Assuming that you--or your client--have filed the return and the FTB has received it, but the FTB has no record that the payment was received, you usually have two choices.

The first one is easy: If the client has the cancelled check, then send the FTB a copy of the cancelled check, a copy of the FTB notice and a memo saying, "Here's a copy of the cancelled check; please correct your records accordingly."

The second possibility is rare, but definitely happens: The client's check hasn't cleared the bank.

In a recent occurrence, the FTB accepted a copy of the bank's stop-payment order that was submitted, along with a replacement check and all penalties and interest were cancelled.

Taxing LLCs as Corporations

If an LLC chooses to be taxed as a corporation, does it pay both the LLC fee (a percentage of gross receipts) plus the corporate tax, whether it is an S corp or C corp?

The instructions on Form 568 are less than clear. However, members who have taken Professor Kitty Wright's California tax class, plus a member who looked it up in the California Revenue & Taxation Code, saved the day when this question recently arose on TaxTalk.

LLCs that choose to be taxed as corporations only pay the corporate tax, not the LLC tax (Ref. CA Rev. & Tax Code Sec. 17941 and 17942).

Head of Household Questions

Many years ago, a section on Form 540 basically was a Head of Household questionnaire.

Somewhere along the line, it disappeared and was replaced by a mailed questionnaire, which was costly for the FTB to mail and process. For years, Committee on Taxation members (at least one anyway) said at the FTB Liaison meetings that if the information is so important, then it should be part of the tax return.

E-filing has resulted in Head of Household information being required for electronically filed returns. However, the requirements still confused many people, including CPAs.

Consider the following: A male client has his fiancee and her child living in his home for the full calendar year and provided more than half of the child's support. Does he qualify as a Head of Household?

No, because the individual who qualifies a taxpayer to claim Head of Household status must be either the taxpayer's child (including step, adopted or grandchild), foster child or other relative who qualifies as a dependent.

The child can't be considered a foster child since the Board of Equalization has ruled that a child whose parent lives in the home does not qualify as the foster child of the non-parent living in the home [Appeal of Michael E. Curtis (97-SBE-012)].

Thanks to these TaxTalk participating CPAs for their input on these issues: Michael Chambers, Jim Counts, Dale Isaacs, David R. Kelly, Robert Allen Kosbie, Larry Massey, Bob Plante, Terry Seiberlich, Bob G. Trimm and Tuyet Vu.

By Leonard W. Williams, CPA 

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Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner. A member of CalCPA's Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president, you can reach Williams at [e-mail].