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Demystifying EDD employee classification audits

On Behalf of | Feb 11, 2022 | Corporate Taxes |

Words like “payroll,” “tax” and “audit” can be a bit frightening for most employers, representing complex compliance regulations, a time consuming and costly legal process and potential legal problems. The prospect of an audit from California’s Employment Development Department can be extremely intimidating for any employer.

While these initial associations have some truth to them, the most intimidating aspect of these issues is the unknown. Understanding the nuances of an EDD audit can help reduce the challenges presented and can help you handle the audit in such a way as to get better results and protect your company’s future.

What is the Employment Development Department (EDD)?

The EDD is a California state tax agency responsible for several areas. The most important of these for many employers is the auditing of employee classifications. The EDD will audit employers and their classification of workers as independent contractors.

How does the EDD determine classification?

While the IRS uses its own independent classification system, the EDD uses a number of factors to determine whether a worker should be considered an employee or contractor.

According to the EDD’s Employment Determination Guide, the guiding principle factor is “whether the principal has the right to control the manner and means by which the work is performed.”

Some questions that can help determine whether a worker should be classified as an employee include:

  • Whether the employer can fire the worker at will
  • Whether the employer has to instruct and supervise the worker
  • Whether the work is considered part of the employer’s regular business
  • Whether the worker has his or her own separate business entity

These are good questions to get you started on determining a worker’s proper classification.

What are the potential consequences of an audit?

If the EDD’s audit results in a determination that you have classified the workers correctly, there would be no negative consequence other than the time spent dealing with the audit. However, if you have misclassified any employees as independent contractors, this determination could result in significant consequences for your business.

Penalties for unpaid taxes, including federal social security, income tax and unemployment, as well as state taxes; fines for breach; potential lawsuits from the employee and bad press can all harm a business for misclassification.

What to do if you are audited?

The most important thing you can do is work with an experienced tax lawyer who knows how to protect your business’s interests in an audit. There are ways to show proper classification, options for appeals from unfavorable decisions and other options available to protect your business from the negative consequences of a determination of misclassification.

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