California business owners are familiar with the ever-present threat of an EDD audit. EDD audits businesses for a variety of reasons. In some cases, they may have suspicions of a business using incorrect filing practices, in other cases, EDD may audit businesses because of contractors who filed for unemployment insurance or even because of being in the wrong place at the wrong time during an EDD site sweep.
EDD does not have the resources to audit all California employers every year so the best way to avoid an audit is to ensure you are avoiding the most common audit triggers. Here are the top 4 triggers that may cause an audit of your business.
1. 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.
The difference between an employee and an independent contractor is determined by the new ABCs of worker classification as outlined in AB-5. Among the criteria used is: “direction and control.” An employee does not control of how, when, and where work is performed, whereas an independent contractor determines these elements for themselves. If your business has misclassified an independent contractor as an employee – whether intentionally or not – you may be at risk of an audit and penalties from EDD.
2. Employee complaint
If an employee, or an anonymous source, files a complaint against a business to EDD, there’s a high possibility that they will decide to audit that company.
Employees may decide to file a complaint against their employer to EDD for multiple reasons. If they have not been paid on time or are incorrectly classified against their will, they may decide to file a complaint to EDD. If a complaint is filed against your company, EDD will likely perform an audit to investigate the employee’s claim.
Complaints can be filed by directly contacting EDD. Employees may file complaints regarding unemployment, payroll, disability, and more. If you think that you may have had an employee file a complaint against your business, your safest option is to contact a tax attorney immediately to ensure that you are prepared in the event of an audit.
3. Late Filing of Taxes
EDD requires businesses to file a variety of various forms throughout the year. This includes filing information about your employees, independent contractors, payroll taxes, and quarterly returns. These forms each have very specific annual due dates.
If your business does not complete the required forms within the correct time frame it may trigger an EDD audit. That said, regardless of whether or not your business is audited for filing taxes late, doing so will make you responsible for late fees and penalties.
4. Randomized verification audit
Verification audits are for all intents and purposes, 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.
As long as you are consistently taking responsibility to ensure that your tax and payroll filings are correct, a random audit should not be a problem for your business. EDD prioritizes audits of businesses that they suspect may be guilty of wrongdoings but that doesn’t mean it’s impossible for even innocent businesses to be audited. A verification audit is the only type of audit that does not result from a suspected wrongful act.
If audited, EDD will request payroll records, 1099 forms, financial statements, etc. so you should be certain to keep yours organized in the event of an audit. At the culmination of your audit, EDD will conduct an exit interview to share the results of their audit. Based on their findings you may have finished with no penalty, or you may have over or underpaid. If this is the case you will either be issued a reimbursement or will be charged for the amount that you owe.
Avoid triggering an audit by correctly classifying your employees. Contact us at got1099 to check the status of your independent contractors and employees.
Originally published for Milikowsky Tax Law in October 2020.
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got1099 is a business reporting company providing business analysis reports to companies re: their 1099 independent contractors We do not provide legal advice. Consult with your attorney relating to any legal issues.