When California’s Employment Development Department (EDD) audits your business, it can be a daunting and complex experience. When the EDD initiates a payroll tax audit, it is typically to ensure businesses have properly reported wages, classified workers correctly, and paid the appropriate employment taxes.
An audit notice does not by itself mean the EDD has found wrongdoing. Often it is verifying records or clarifying payroll practices. Knowing what the auditor can ask for, and what you are required to produce, is what makes the process manageable. Below are five tips for employers preparing for an EDD audit.
Cooperate With the EDD During the Audit
First and foremost, prioritize fully cooperating with the EDD throughout the entire audit process. This means providing all requested documents and information and answering any questions the auditor may have.
Remember, the EDD is performing this audit to ensure adherence to the state’s employment and tax regulations. By being cooperative, your cooperation will demonstrate your commitment to upholding these standards, likely resulting in a more favorable outcome.
Understanding the EDD Audit Process
The EDD generally conducts payroll tax audits to verify that businesses have properly reported wages and paid required employment taxes such as unemployment insurance contributions, employment training taxes, and state disability insurance. According to the official EDD payroll tax audit guidance, employers are required to maintain accurate payroll records and provide them during the audit when requested.
The review process may include examination of the following:
- Payroll registers
- Employee classifications
- Contractor agreements
- Tax returns and payroll filings
- Business accounting records
Providing organized documentation can make a significant difference in how smoothly the audit proceeds.
Maintain Professional Communication
Employers should remember that auditors are performing regulatory duties, not acting as adversaries. Maintaining clear and respectful communication can help resolve questions quickly and reduce misunderstandings. When employers cooperate and provide accurate records, audits often conclude more efficiently.
Never Underestimate Your Liabilities
As a business owner, you are ultimately responsible for errors or discrepancies within your company’s financial records. To protect yourself from potential liability, be proactive in understanding your true financial picture. This includes familiarizing yourself with California’s employment and tax laws, reviewing your financial practices, and ensuring full compliance. By being diligent and proactive, you can better defend your business against unexpected liability during the audit.
Common Issues Discovered During EDD Audits
EDD audits frequently identify issues related to worker classification and payroll reporting. Businesses sometimes misclassify employees as independent contractors, either unintentionally or due to a misunderstanding of employment regulations. Misclassification can lead to unpaid payroll taxes, penalties, and retroactive assessments.
Employers may also face liabilities if wages were under-reported or if certain forms of compensation were not properly included in taxable payroll.
Penalties and Interest Can Increase Liability
If the EDD determines that taxes were underpaid, the agency may assess penalties and interest in addition to the unpaid tax amount. The official EDD penalties and interest guidelines explain how financial penalties may apply when employers fail to properly report payroll taxes or meet filing obligations.
Because these liabilities can accumulate quickly, employers should carefully review their payroll records before the audit begins. Identifying potential issues early allows businesses to prepare explanations and supporting documentation.
Take Steps To Prevent Other Penalties
When the EDD finishes the audit, it may find that you owe an amount. You can appeal these findings. However, if you decide to pay it or if the appeal does not rule in your favor, you must pay what you owe within 30 days. Otherwise, you may incur fines that add to your debt and financial woes. These can increase over time, depending on how late your payment is.
Review Worker Classification
Worker classification remains one of the most heavily scrutinized issues in employment audits. California law has strict standards determining whether a worker qualifies as an independent contractor or employee.
If workers are misclassified, employers may be required to pay unpaid payroll taxes, interest, and potential fines. Reviewing contractor agreements and ensuring they comply with state guidelines is an important preventative step.
Maintain Proper Payroll Records
Employers should maintain detailed payroll documentation, including wage records, employment agreements, and tax filings. Accurate documentation not only helps demonstrate compliance but also protects businesses in the event of disputes during the audit process.
Businesses looking to understand compliance risks often benefit from reviewing guidance on employment tax compliance and employer obligations published by legal professionals. Having proper internal controls and compliance systems in place can significantly reduce the likelihood of penalties during an audit.
Know When To Turn in Your Petition
If you disagree with the EDD’s audit findings, you have 30 days from receiving your assessment to file a petition for an appeal. Although a late filing can prevent you from forming a settlement, you can get an extension if the administrative law judge sees ample reason for it.
Understanding the Appeals Timeline
Employers who receive an adverse determination typically have a limited period to submit a petition or appeal. The exact deadline can vary depending on the nature of the determination, but it is usually within 30 days of receiving the notice.
The appeals process allows employers to present additional evidence, clarify misunderstandings, or challenge incorrect conclusions made during the audit.
Preparing Supporting Documentation
A successful appeal often depends on documentation. Employers should gather payroll records, tax filings, employment contracts, and financial records that support their position. Organized documentation can strengthen the employer’s case and improve the chances of a favorable outcome.
Businesses navigating an audit dispute may also benefit from reviewing legal guidance on employment compliance and employer defense strategies provided by experienced employment attorneys, such as the legal resources available through Pershing Square.
Seek the Help of an Attorney
Obtaining legal counsel to assist you is another good tip for employers preparing for an EDD audit. An attorney familiar with California’s employment and tax regulations can help review your documents, advise on compliance matters, and represent you during an audit or an appeal. An attorney can also handle the audit correspondence, which lets you keep running your business while the audit proceeds.
Following these five steps puts you in a better position if an audit begins. If you are unsure how to respond to a notice, or which records the auditor is entitled to, speaking with an attorney can help you understand your options.
Our note on the mistakes employers most often make during an audit covers what to avoid, and our payroll tax audit team works with employers through the audit and any appeal that follows.
