If you are employing workers as a business, there’s a chance the Employment Development Department (EDD) may audit you. They conduct standard procedures to find any errors or discrepancies among the classification of W-2 and 1099 employees. There is a difference between the two, and the correct classification is imperative to ensure you and your business do not suffer penalties or fines during an audit. 

Audits are meticulous and require vital information from you. Learn more about the audit process and frequently asked questions that can help you with your audit. 

Why Was I Selected for an Audit?

There are a few different reasons why you can be selected for an audit. The first reason an audit may occur is because you were randomly selected. EDD chooses random companies to complete a verification audit. This particular scenario means nothing provoked EDD to look into your company besides random selection. 

A common trigger for an EDD audit is when an independent contractor files for unemployment. This causes a red flag for EDD because 1099 independent contractors are self-employed and cannot qualify for unemployment. If they list you as an employer when applying for unemployment, it could mean you misclassified them as a W-2 instead, or they were unaware of their ineligible status. 

Employees themselves can report you to EDD for various reasons. If you fail to pay wages due, pay less than is owed, or willfully do not classify workers, they can notify EDD.

If you are overdue on your tax submission or your tax payment, EDD can be triggered to begin an audit investigation on your company. 

How Will I Know If I’m Selected for an Audit?

EDD will send you a letter notification in the mail. When you receive the audit notification, open the letter immediately and begin the next steps because you have 10 days to reply to the letter. 

When you receive the package, it will include a list of questions for you to fill out.  

What Do I Do If I’m Selected for an Audit?

Complying with the requests in your audit letter is your key to successfully completing the audit. Late submissions, withholding or neglecting information will not help your case, nor will it benefit you or your business in the long run. 

The first step is to prepare for the audit. Organize all requested information and paperwork. This can include: 

• Answering questions in the audit packet (preferably with a tax attorney) from the pre-audit questionnaire
• Contractor agreements
• Tax returns
• Pay stubs
• Documents proving the independent contractor owns his or her own business
• Submit cash payment receipts 

The next step is the Interview with the EDD auditing agent. If you have met with an attorney, this process is relatively straightforward. The attorney will have helped you organize your information and prepare the answers to the EDD auditor’s questions. 

How Many Years Back Can EDD Audit Me?

EDD can audit you back three years. Typically, they audit the most recent year depending on each case. If they find something alarming during the audit process that requires them to look further back, they can request records from up to seven years. 

What Do I Do After My Audit?

After your audit has been processed by your auditor, you will partake in an audit exit interview. These are done either through the phone or in person. The auditor will go over what they found and discuss the conclusion of the audit. There are four outcomes for an audit:

• Nothing was found – no change 
• Overpayment – you will be reimbursed for your overpayment 
• Underpayment – the auditor will go over what is owed
• Simultaneous overpayment and underpayment. 

There are different penalties depending on the results of the audit itself:

• Misclassifying an employee as a W-2 instead of a 1099 typically results in a $50 fine per misclassification. 
• Charge of 1.5% of employee wages to make up for income tax withholding 
• Payment of 40% of employee payroll taxes
• Matching 100% of payroll taxes plus interest 
• 0.5% penalty for the Failure to Pay Taxes penalty for each month of delinquency 

More serious penalties result in heavier fines. If EDD finds intentional misclassification, fines can result in 20% of wages paid plus 100% of payroll taxes. Misclassification of a worker can rise up to $1000 per misclassification and even a year in prison. 

Get ahead of an audit and make sure you classify W2 and 1099 employees correctly. Determining the classification of your workers individually takes time and effort away from you running your business. Contact our expert team at got1099 to go through the process for you, and avoid the headache of fines and penalties if EDD finds misclassified employees. We will correctly classify your employees, and walk you through the steps to transition improperly classified employees to their correct classification.