California’s Employment Development Department (EDD) can audit your company when one of your independent contractors tries to obtain unemployment benefits. This process can be costly and taxing, but you can better survive it by not making certain errors. An Employment Development Department (EDD) payroll tax audit can feel like “just paperwork” at first—until you realize how quickly it can turn into a five-figure (or six-figure) assessment, personal liability concerns, and a long trail of deadlines.
EDD’s own materials make clear that these audits are designed to verify compliance with the California Unemployment Insurance Code (CUIC), confirm proper worker classification, and ensure wages and payroll taxes are correctly reported. Learn the common mistakes to avoid during an EDD audit so you can make better decisions for your business.
Understanding What an EDD Payroll Tax Audit Is (and Why It Gets Expensive Fast)
Before we get into mistakes, it helps to understand what the auditor is actually looking for.An EDD payroll tax audit generally examines whether a business has accurately reported wages, properly classified workers as employees vs. independent contractors, and paid the correct payroll taxes. EDD describes the audit as a formal review authorized by the CUIC and Government Code, and it focuses on compliance and worker benefit protections.
What the audit period can cover
EDD explains that audits cover a “period” (often multiple years), and if issues are found, the financial impact can multiply because the assessment may span across that full timeframe.
What EDD typically requests
EDD’s audit process guidance outlines the overall flow (notice, records request, interviews, review, and conclusions), and EDD’s audit guidelines discuss employer responsibilities and audit procedures in detail.
In plain terms: you’re likely going to be asked for payroll records, contractor payments, bookkeeping reports, and documents that show how you decided someone was a contractor rather than an employee.
If you treat the audit like a minor inconvenience, you can accidentally create bigger problems than the audit itself.
Ignoring the Seriousness of an Audit
One mistake to avoid during this process is ignoring the seriousness of the situation. It will not “just go away.” The department is performing this audit because they want to see if you misclassified your contractors and will want to investigate the recent years of your business. It may cost you thousands of dollars or even more if they find that you have committed violations.
How employers get trapped by “delay thinking”
A lot of business owners delay because they assume:
- “We’re small; they won’t dig deep.”
- “Our accountant already filed everything; we’re fine.”
- “If we just hand over what they ask for, it’ll go away.”
But delays tend to create messy records, missed deadlines, and inconsistent explanations and those are exactly the things that make auditors suspicious.
The real risk of casual or incomplete responses
EDD’s audit guidelines emphasize employer responsibilities during an audit, and the audit process guidance shows the audit is designed to determine compliance and classification accuracy.When you respond late, respond partially, or respond in a disorganized way, you increase the chance the auditor:
- expands the inquiry,
- requests more documentation,
- questions classifications more aggressively, and
- calculates liabilities using conservative assumptions.
What to do instead
Treat the first EDD audit letter like a “start now” moment:
- Create a dedicated audit folder .
- Assign one person to coordinate document gathering (even if you’re the owner).
- Make a clean timeline of who was paid, how, and under what role.
- Avoid off-the-cuff phone explanations—write down facts first.
For deep understanding see our Pershing Square Law’s guide on preparing for an EDD audit walks through common preparation principles in a way most employers can follow.
Not Hiring a Lawyer
Some employers hire counsel too late after they’ve already said the wrong thing, produced the wrong documents, or accepted an audit narrative they can’t easily unwind.
This isn’t about being dramatic or “fighting the government.” It’s about recognizing that EDD audits can hinge on legal interpretations, especially around worker classification and what counts as “wages” for payroll tax purposes. EDD’s audit process materials explicitly include proper worker classification as a core audit purpose.
Why “I’ll just use my accountant” can be risky
Accountants are essential—but a payroll tax audit can involve legal issues beyond bookkeeping accuracy, such as:
- whether a worker should have been treated as an employee,
- whether reimbursements or certain payments count as wages,
- whether officer/owner compensation was handled properly,
- whether the business is exposed to penalties based on conduct.
Legal representation is particularly important when an audit may result in a formal Notice of Assessment and subsequent appeals.
The interview and the narrative
One overlooked moment is the entrance interview (or early audit calls). Employers often “explain too much” or guess at answers. Then those guesses become the audit narrative.
Even well-meaning statements like, “They’re basically like employees, but we pay them as contractors,” can open the door to reclassification issues.
Know your appeal pathway
To keep your process grounded in official materials, it’s smart to reference EDD’s own audit overview, the Employment Tax Audit Process (DE 231TA), and if you’re at the challenge stage, the Petition for Reassessment or Review (DE 1009) guidance—both directly from EDD.
What a lawyer actually helps with during the audit
A strong EDD audit attorney can help you:
- control the flow of information (give what’s required, not “everything you have”),
- prepare clean, consistent explanations supported by documents,
- identify classification vulnerabilities early,
- challenge incorrect assumptions before they solidify into an assessment, and
- set you up for appeal rights if the audit goes sideways.
For a plain-English look at common audit triggers and how employers can reduce exposure, Pershing Square Law also has a helpful resource on mitigating the risk of an EDD audit.
When hiring counsel is most valuable
The best time to hire legal support is before:
- you submit a large document package,
- you participate in interviews, or
- EDD issues a proposed or final assessment.
Trying to do this without an EDD audit lawyer is another common mistake to avoid. You are likely not an expert in the audit process, so don’t try to go into one without the guidance of someone with the right expertise.
Paying the EDD Assessment Without Challenging It
Part of you may consider ending the audit process by paying the EDD assessment without challenging it. This strategy is also a mistake. A lawyer can help you file the appeal and develop a settlement with the EDD.
That settlement may help you develop payment terms you are comfortable with and reduce the amount that you must pay. You will be glad you saved your company considerable costs by seeking the assistance of an attorney.
Contact Pershing Square Law Firm today if you need the representation of an experienced payroll tax audit defense lawyer. We have a strong record of lowering the assessments of our clients and are fully qualified to manage your audits with EDD auditors.