Payroll Tax Audit
The California Unemployment Insurance Code (CUIC) and the Government Code authorize the Employment Development Department (EDD) to conduct payroll tax audits of businesses operating in California.
A payroll tax audit can be exceedingly complicated and frustrating for business owners. The EDD has broad powers to examine records and books as well as mandate the appearance of the taxpayer, their employees and other parties.
The typical EDD payroll tax audit begins with an Inquiry Regarding Records letter that informs the employer that the company has been selected for an audit. This introductory letter will request the EDD be contacted within 14 days to arrange an in-person EDD-taxpayer interview. Included with the letter is a Pre-Audit Questionnaire and a request of documentation the EDD requires for the audit.
The auditor will conduct an entrance interview before reviewing records to explain the purpose of the audit and the audit process as well as gather information about accounting records and about the operation and organization of the business. It is best that a legal representative conduct the meeting alone with the auditor, preferably in the representative’s office.
An audit begins with the examination of records for a test year, which is generally the most recent completed calendar year.
The auditor will review the employer’s books and records to:
- Verify the business ownership and type of entity.
- Verify that all individuals paid for services have been properly classified as either employees or independent contractors.
- Discuss any unreported payments made for personal services and the nature of the working relationships with the employer and workers.
- If selected for a complete audit, the auditor will also verify gross and taxable wages have been properly reported and personal income tax for wages has been correctly withheld and reported.
If discrepancies are found in the test year, the examination might be expanded to include the records for the entire period covered by the audit.
Statute of Limitations
There are time limitations for the EDD on the records it can examine. If quarterly EDD employment tax returns have been filed, the statute of limitations for assessment is up to three years, comprising the twelve most recently completed calendar quarters. In some instances, such as when no returns were filed, the audit period might be longer. If the EDD suspects fraud, whether or not a return has been filed, there is no statute of limitations for assessment.
If the audit process drags on for a long period of time, the statute of limitations on older employment tax quarters involved in the audit might expire. The auditor might ask the taxpayer to sign an audit statute of limitations extension so those quarters do not expire. However, it is important to know that it is okay to say no. The taxpayer is not required to grant a statute extension and cannot be treated adversely for refusing to do so.
Upon the completion of the audit, the auditor will arrange an exit interview to review the audit findings, identify any other information that should be considered and attempt to resolve any disputed issues. If the taxpayer cannot reach an agreement with the auditor, he or she can request a pre-assessment conference with the supervisor of the auditor.
The audit will result in one of the following:
- A no change audit, where no differences are found.
- An overpayment, where a credit or refund will be issued.
- An underpayment, where the differences will be assessed.
- Both an underpayment and overpayment. For example, the auditor might find that a business has overpaid SDI, but underpaid PIT.
Appeal of Decision
The EDD has no interim appeal process similar to the Franchise Tax Board or the State Board of Equalization. Rather, the only appeal available is a formal appeal to the California Unemployment Insurance Appeals Board (CUIAB).
IRS Exchange Agreement
The results of the EDD payroll tax audit are made available to the IRS, which might use the information to conduct a full-scale payroll tax examination. The IRS can also use the work papers of the EDD and base its assessment upon EDD findings.
Do Not Assume
Just because you are a good and honest businessperson does not mean the EDD will believe your story and the audit will be a breeze. Facing an EDD payroll tax audit can be extremely stressful and confusing, and usually requires the help of an experienced EDD payroll tax attorney. Brown, PC can help guide you through your audit and work with the EDD for the best possible results. We represent clients in Los Angeles and throughout California. To speak with one of our attorneys regarding your matter, please contact the firm online or by calling 817-870-0025.