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Unwanted attention.

business might be audited for several reasons, from random causes to someone turning them in to the Employment Development Department.

When being audited by the EDD the norntal process is to begin with the last three years ending with the latest closed calendar quarter. If the business has not been filing payroll returns reporting any employees, then the EDD can go back eight years.

the following discusses some of the main reasons a business might. be audited by the EDD.

Obstructed Claims Audit

The majority of EDD audits relate to a worker who was paid as an independent contractor and then files for either unemployment insurance or disability insurance benefits. This is called an "obstructedstru claim" audit. After the EDD interviewer gets some information. the claim is turned over to the EDD's Field Audit and Comipliance Division ho determine if the worker should have been reported as employee. The EDD then has 10 (days to dletermine if the worker is entitled to benefits.

Given the short time period, the worker is likely to receive the benefits and the EDD would then audit the business.

Underground Economy

California agencies are working together to find underground economy businesses that are not paving their taxes. California law has set up die Employment Enforcement Task Force, Construction Enforcement Task Force. Construction Enforcement Project and joint Enforcement Strike Force.

Each of these groups work different areas of the underground economy as they hunt for businesses that are not reporting and paying taxes. or being incorrectly licensed. Each group consists of representatives of several agencies including:

* EDD;

* Franchise Tax Board: Board of Equalization:

* Department of Industrial Relations; Contractors Slate License Board:

* Department of Consumer Affairs:

* Department of Insurance: and

* Department of Justice.

For more information about these groups, see the EDD information sheet DE63I ( and visit the EDD underground economy webpage (www. calcpa. org/undergroundecon )

Department of Labor

Much of the funding for the FDD comes from the DOL, which requires the EDD to do a full payroll audit on some employers. The EDD will he looking at such things as correct computation of gross and deductions on the paychecks, whether payroll tax returns are being filed and on time, whether deposits are being made in the correct amounts and on lime, and more.

The DOL wants the EDD to do audits of all types on 1 percent of all California employers. The EDD has about 1.3 million employers and is only doing about 6,000 audits a year.

IRS Audit Results

The IRS and EDD have an agreement that each will provide the other with information on their respective payroll audits.

When talking with IRS group managers. I've been told they see all of the EDD audit results and decide how to move forward with the information. When I talk with tax practitioners, mam have said that they have not seen the IRS come in or make an adjustment based on the EDD audit results in even case. Whether the size of the audit adjustment or type of audit adjustment makes a difference as to if the IRS audits or not is unclear.

The EDD does not have an equivalent to the IRS Voluntary Classification Settlement Program ('CSP). The IRS states it will not provide information to the EDD on any business requesting the program. The EDD says, if it audits the business, it wants all the back years of taxes with no reduction for coming forward voluntarily.

Form 1099MISC

The IRS provides the EDD with information on Form lO99MISCs. which is filed by California businesses. In reviewing these filings, the EDD will select various businesses and call to ask questions on what the workers are doing. 1 have had the experience of working with one such business that was called, and I had to provide information on what work the worker performed for each form. The EDD is Irving to determine quickly if it appears some, or all. of the workers should have been reported as an employee. it identifies workers that should have been reported as an employee, then the business will be referred for an audit.

This is not a high percentage of the EDD workload as ii gels more audit leads than it can handle through their other audit leads.

Someone Turned in the Business

This type of audit is a catchall lor several audit leads, the EDD receives leads from competitors, ex-spouses, court employees or some person hearing someone saying a business is not doing something correctly. While the EDD will follow up on these leads, il does not automatically do an audit just because someone says a business is doing something wrong.


While there are several reasons why a business might be audited by the EDD. the most likely is because a worker who was paid as an independent contractor filed lor unemployment or disability insurance benefits and the EDD has no record of wages paid to the worker. While the EDD liability is one to be concerned about, it's jusi a small piece of the overall potential liability that includes such things as:

* IRS taxes, penalities and interest;

* Labor Commissioner worker wages such as overtime and penalties for not providing rest and meal breaks;

* II the business provided other workers health insurance and the worker lias to be reimbursed for what the worker paid, which the insurance would have paid if he or she was covered; and

* If the business had a pension plan for workers.

These audits should not be taken lightly, bin I find, in main cases, either business owners will try to handle the audit or a lax practitioner not knowledgeable about EDD matters will try to handle the audit. What follows, toward the end of the audit when the practitioner or business owner gets an idea the size of the adjustment. they will seek assistance. At that stage some things may still be able to ix' dune. but it's too late in the process for controlling the audit.

The IRS and EDD have an agreement that each will provide the other with information on their respective payroll audits.

Reviewing Reasons Why the EDD Would AuditYour Client

James C Counts II, CPA CTFA is a solo practitioner in Hemet and is the liaison to the Employment Development Department for the CalC PA Committee on Taxation. You can reach him at
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Title Annotation:auditing guidance
Publication:California CPA
Geographic Code:1USA
Date:Sep 1, 2014
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