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Is there a difference between EDD and IRS worker classifications?

On Behalf of | Mar 31, 2022 | Audits |

When it comes to taxation for employers, one of the most important determinations involves the classification of workers. There are significant implications for classifying a worker as either an employee or private contractor.

The risk comes into play when The Internal Revenue Service (IRS) or the California Employment Development Department (EDD) audit your classifications. There are severe penalties for misclassifications, so it is critical to understand how these administrations analyze classifications.

The most important fact to note here is that the IRS and the EDD have some significant differences in how they determine worker classifications, and you need to understand both to avoid tax law problems.

The Similarities

Both the IRS and the EDD focus on similar factors when determining classification. Although they use a different number of factors (the IRS uses 20-factor test and the EDD uses 13 questions), they both ask the question, as the basic test, of how much the employer controls the manner of the work being done. They also both look at issues like the right of termination, financial risk of loss and whether the work being performed is a regular part of the employer’s business.

Although there are similarities in the inquiries used by both organizations, it is important to note that there are some critical differences between the two, and a worker being classified as a contractor by one will not necessarily mean that the other will follow that classification.

The three primary difference between the two

In general, the IRS differs from the EDD in ways that make the IRS less demanding and less potentially costly.

  1. The Safe Harbor provision: According to the Revenue Act of 1978, Section 530, the IRS cannot classify a contractor as an employee retroactively. As long as the employing organization consistently treated the worker as a contractor, fulfilled the reporting requirements for contractors and had reasonable basis for the classification, the IRS cannot change the classification.
  2. Reduced penalties: When an employer is deemed to have misclassified an employee as a contractor, the IRS has some reduced penalties that soften the financial blow a little. The EDD< however, does not.
  3. Settlement programs: The IRS also provides a couple of settlement programs in which the violating employer can minimize exposure. The Voluntary Compliance Settlement Program and the regular Compliance Settlement Program both allow businesses to cut down on the tax penalties they could face from misclassification. The EDD offers no such settlement programs.

The takeaway of all this is two-fold: First, avoid assuming that a certain classification by one entity will be the same as the other. They often are the same result, but it does not necessarily shake out this way in every case. Second, make sure that you make your classification determinations carefully, because there are severe penalties for misclassification. The stakes are too high to get this wrong.

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