The Employment Development Department (EDD) is the largest tax collection agency in the state of California. They’re responsible for collecting payroll taxes from over 17 million workers annually, accounting for over $31 billion in tax payments. The agency also offers various services to California residents through the Job Service, State Disability Insurance (SDI), Workforce Management, and Labor Market Information programs. 

Because of the high responsibility it holds, EDD cracks down on businesses that fail to file the correct forms or make appropriate payroll tax withholdings. Dealing with EDD leaves small business owners and employers little room for mistakes.

While EDD may be intimidating to small business owners, knowing how to properly prepare and protect yourself is key. Keep reading to learn about EDD audits and how verifying the status of your 1099’s can help you predict if your business should expect to be faced with an audit.

What is EDD?

EDD offers a variety of services to residents of the state of California. As one of the largest state departments, they’re responsible for various state programs regarding employment within the state. EDD collects payroll taxes and audits businesses to maintain consistency across the state. Additionally, they are responsible for administering the Unemployment Insurance and State Disability Insurance programs.

When does EDD perform audits?

There are various situations that may trigger EDD to perform an audit of your business. The top 4 more common EDD audit triggers include the following:

• Independent contractor filing for unemployment

A worker that is correctly classified as a 1099 independent contractor is not eligible for unemployment. If a contractor lists your business in an application for unemployment benefits it raises a red flag to EDD. It may have been that the employee was simply unaware that they are ineligible, but EDD usually takes this as a sign that they may be an incorrectly classified worker. 

• Employee complaint

If an employee or anonymous source submits a complaint about an employer to EDD, they are very likely to perform an in-depth audit of that business. Employees may decide to submit a complaint against their employers for various reasons. These reasons include incorrect or delayed payments, or the employee has been wrongly classified against their will.

• Late Filing of Taxes

EDD requires businesses to file a variety of employment forms throughout the year, each of which has specific deadlines for submission. Should your business fail to submit the required forms within the required time frame, it may serve as a red flag for EDD to investigate why. 

• Randomized verification audit

Verification audits are random. EDD uses verification audits regularly to ensure that businesses are following proper guidelines for employee classification and payments. This is the only type of EDD audit that is not the result of a specific allegation or claim against a company. 

How should I prepare for an audit?

The EDD audit process begins with the receipt of notification of the audit. This notification serves to inform your business that EDD intends to audit the filing and payment of your payroll taxes. The initial documentation that you will receive from EDD includes the compilation of records and information that they will collect and review as part of the audit. It also includes a list of questions for you to answer in anticipation of the audit. 

Once your business has received this notification, you can begin answering the required questions and collecting the necessary documentation and reporting requested. It is also in your best interest to consult a legal professional for expert advice on how best to protect your business. 

What is the process of an EDD audit?

You should be sure to specifically follow any and all directions from EDD during your audit precisely. Making things more difficult or withholding information from EDD throughout this process will not benefit you and your business. 

Typically EDD will review three years of payroll taxes when performing an audit. This may however be extended should they see a reason to do so. 

There are various ways that an auditor can classify various employees. There is always a possibility that an auditor can utilize various factors of classification to favor EDD against the interests of the business being audited. The support of an experienced tax attorney can assist in protecting your business against such actions. 

What happens after my audit?

The consequences of an audit may vary depending on the findings of the investigation. Employee misclassification audits often result in a $50 fine per incorrectly classified employee. In addition to these charges, audited businesses may also face penalties and fines in accordance with the severity of their wrongdoings. Some potential outcomes include the following: 

• 1.5% of employee wages to compensate for income tax withholding
• 40% of employee payroll taxes
• 100% of matching employer payroll taxes plus interest on each of these penalties
• Failure to Pay Taxes penalty of 0.5% of the unpaid tax liability for each month of delinquency

Navigating an EDD audit can be intimidating for most business owners. While there are a number of reasons that EDD may decide to audit your business, one of the most common is the misclassification of independent contractors and employees. 

Save your business the stress of wondering whether you’ll be faced with an audit and partner with our team for an internal audit of your workers. Take the time to answer questions for yourself before it’s too late and EDD dives in to find the answers for themselves.