When most people hear the term “audit,” they think of the IRS. They also think of a confusing process that can take months or years. In California, business owners need to be aware that an audit by the state Employment Development Department (EDD) can also have costly results if not handled properly.
These audits typically look at whether a business is meeting its payroll tax obligations and providing the proper benefit coverage that employees are entitled to. Disputes usually arise over a company’s classification of some workers as independent contractors, who are not entitled to benefits.
How do the audits work?
EDD audits typically cover a three-year period. However, the agency may decide to look back further if they wish. The agency will then set an initial interview date, where they will gather information about your business. Records that you will need to make available to the auditor include, but are not limited to:
- Annual financial statements and banking records
- Ownership verification documents
- Federal and state tax records, including employees’ W-2, W-4 and quarterly tax return (Form 941) forms
- Payroll records
- Agreements with independent contractors
The auditor will review your records and ask questions or ask for more information. At the end, the auditor will issue their findings. If they find that you have not paid proper payroll taxes, possibly because of misclassifying employees as independent contractors, you could face heavy fines.
The EDD may also choose to share the findings of your audit with the IRS. This could open the door to another lengthy investigation and even more financial penalties.
Know your rights and options
Do not ignore the initial notice of the audit, and do not ignore requests for information from the EDD. Instead, start preparing immediately. Consider speaking with an experienced tax attorney who can walk you through the process and help you prepare for the initial interview.
Additionally, should you face serious fines, there is an appeal process. Having an experienced attorney in your corner who knows how the appeals process works will be advantageous.