rs-california-payroll-tax

So if you can’t reach a resolution in a payroll tax audit you have essentially three options. The first option is to deal with the auditor and their manager. Oftentimes this can be problematic. Obviously this depends on the two people that are involved and people are people. Like any other organization, you get good people and you get bad people so depending on the relationship with the auditor that’s been developed during the course of the audit and depending on the relationship of the manager, it’s going to change the dynamic on how things are resolved at that level. Going to the manager is always an option. Generally speaking, the audit manager is going to back their auditor’s determination. It’s not like the manager is going to sit there and throw the auditor under the bus. The purpose of bringing in the manager is you get somebody more senior. You get somebody who usually is a former auditor but who has exposure to dealing with these issues and can often resolve tensions if they popped up in the audit process by being kind of a third party representative for the government to come in and resolve the situation. The managers don’t really like dealing with these issues. They would rather their auditor deal with these issues and not go to the manager but there is a possibility. Above the manager of the EDD level, you also have the head of the audit division.

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So in January of 2020, California Legislature passed AB5 which governed the relationship between companies and their workers. Basically what AB5 states is that unless a hiring entity can prove that a worker is truly independent according to three specific factors, that worker will be deemed to be an employee of the company itself. The factors are number one, the company must not have in any condition of control over the work. Number two the worker services must be outside the core business or the hiring entity and number three the worker must maintain their own separate and independent business. So this was all raised with much fanfare and rightly so was called the death of independent contractors in California because unless you qualify for one of the exemptions that’s under the statute, pretty much all workers fall within an AB5 framework and they can be deemed employees. It’s only those that are providing true outside services like they have bookkeeper or CPA or law firm or videographer that really qualify outside the scope of AB5. The statute really is meant to pull as many people as possible into the employee relationship however from a tax perspective despite all the fanfare on the labor side, it doesn’t really have any impact. The reality of the situation is that the EDD has been using an AB5 framework for quite some time. So what I mean by that, well the reality is that when you go through an employment tax audit, EDD is already looking at control. Control was a previous factor under the old past and now really

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So the biggest risk by far in a payroll tax audit is the penalties. The EDD has some really nasty penalties. We’ve had situations in the firm sometimes where the amount of tax would be one number and the penalties would be four or five times what the amount of taxes actually is. That’s insane but the biggest risk that we see is that the penalties really amplify the amount of the liability. So when we’re looking at a payroll tax audit our focus is really on penalties and what we can do to eliminate them or at the very least mitigate them. Number two, the risk in an EDD audit is it turns into a fishing expedition audit if left unchecked. We’ll ask for all sorts of things and we’ll go through them with a fine-tooth comb and this creates a lot of back and forth. All of this can be really mitigated if you pre-audit the situation and if you come into the audit with a very well-defined plan and a very well-defined presentation and you’re leading the auditor through the audit kind of with breadcrumbs to make sure that we’re checking the boxes on the avenues that need to be checked and you’re controlling the flow of information. Controlling the flow of information in a payroll tax audit is the best thing that you can do. It’s difficult once you get into the independent contractor part of this and the reason for that is when you’re dealing with situations with independent contractors, the auditor is going to go out and try and interview those people. The problem and the risk to the client is you don’t know exactly what those people are going to say a lot of times. What will be found is that the auditors will lead them through some of the factors that will make them employees. They shouldn’t be doing that but it is a practical purpose that’s sometimes what happens and in other cases they’re disregarding the information in order to help them build their case. Ultimately the auditor is writing a report so the content of that report

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