The EDD Audit Notice and Pre-Audit Questionnaire: What They Mean and How to Answer

What the EDD audit notice and pre-audit questionnaire are and why you received them

The Inquiry Regarding Records is the EDD’s formal notice that your payroll tax account has been selected for audit, and the pre-audit questionnaire is the auditor’s first piece of evidence about how you run the business and pay the people in it. The audit checks whether unemployment insurance, the employment training tax, state disability insurance and personal income tax withholding were reported for everyone who belonged on payroll. Most audits we see open for one of three reasons: a person you paid on a 1099 filed for unemployment, a worker or a competitor complained, or your DE 542 independent contractor reports were matched against your payroll returns and the gap was large. The questionnaire asks who owns the business, who keeps the books, how many employees you have, and who was paid outside payroll and for what, and those last answers become the auditor’s worker list.

The legal test behind it is the ABC test in section 2775 of the Labor Code. A worker is an employee unless the business shows all three of the following: (A) the worker is free from your control and direction; (B) the work is outside the usual course of your business; and (C) the worker runs an independently established business of the same kind. Several licensed professions and business-to-business contracts that meet a set of conditions are exempt under the sections that follow, and for those the older Borello test applies, which turns mainly on your right to control the work.

The deadline on the EDD audit notice and what happens if nothing is done

The letter sets two dates, one to return the questionnaire and one for the appointment, and missing them does not end the audit; it moves the audit forward without your side of the story. Sections 1085 and 1092 of the Unemployment Insurance Code (UIC) require an employer to make its records available to the EDD, so an auditor who gets no response builds the case from your filings, your bank records and your workers, and issues a Notice of Assessment on the EDD’s numbers, often with the 15 percent negligence penalty under section 1127 of the UIC added. Under section 1132 of the UIC the EDD has three years from the later of each quarter’s due date or filing date to assess that quarter, eight years where no return was filed, and no time limit where fraud or intent to evade is found.

What to do in the first 30 days

The first 30 days are for reading the letter closely, deciding who speaks for the business, and answering the questionnaire accurately in words that do not decide the ABC test against you. In order:

1. Calendar both dates, and if the return date is too tight to answer carefully, ask the auditor for an extension before it passes.
2. Decide who represents the business; a power of attorney on form DE 48 puts that person between you and the auditor.
3. Reconcile the twelve quarters of DE 9 returns, the 1099 forms and the general ledger before the EDD sees them, because the differences are where the audit will go.
4. List everyone paid outside payroll during the audit period, with what they did, how they were paid, and whether they had a contract, a license and other customers.
5. Answer the questionnaire truthfully and precisely, one question at a time, describing contractor work in terms of what the contractor’s business does rather than what yours does, and add nothing the form did not ask for.
6. Gather the records listed below, but produce them in the scope the auditor asks for, not as a box of everything.

Your options once the audit is open

An EDD audit has three honest paths, and which one fits depends on what the reconciliation in step three shows.

• Defend the classifications. Produce the records and the proof of independent businesses, and argue each worker under the ABC test or, for exempt occupations, the Borello factors.
• Concede the weak workers and contest the rest. Where a group plainly fails prong B, agreeing to their reclassification and contesting the others, the personal income tax portion and the penalties usually produces a smaller number than contesting everything.
• Take the findings up the ladder. If the exit interview ends in disagreement you can ask for a pre-assessment conference with the auditor’s supervisor, and once the Notice of Assessment issues you have 30 days under section 1222 of the UIC to petition the California Unemployment Insurance Appeals Board (CUIAB) for reassessment.

What Brotman Law does with an EDD audit notice

For an Inquiry Regarding Records our work in the first thirty days is to take over contact with the auditor, reconcile your filings before the EDD does, and answer the questionnaire so that it reads as evidence for the business rather than against it. The first step is the DE 48 power of attorney, so the auditor deals with us. We then sort everyone paid outside payroll into those who pass the ABC test, those who are exempt and those who are exposed, tell you the exposed number before the auditor computes it, and answer the questionnaire from that analysis with the evidence that carries prongs B and C. Where a worker will be reclassified whatever we do, we say so early and move the effort to the penalties and to the personal income tax portion, which can be reduced where the workers paid their own tax. Since 2013 we have represented 400+ clients in audits, many of them EDD audits.

Do you need a lawyer for an EDD audit notice?

If the audit period is the standard twelve quarters, you paid anyone on a 1099 who worked mostly for you, or you are an owner or officer who could be held personally liable for the result, this is a lawyer matter, because the questions are legal ones and the answers are being recorded. Under section 1735 of the UIC an officer, major stockholder or other person in charge of a corporation’s or limited liability company’s affairs who willfully fails to pay the assessment is personally liable for it.

The honest exception is the business that paid no one outside payroll, whose DE 9 returns reconcile to the ledger, and whose only question is a one-year reconciliation with small dollars at stake. Your accountant can handle that, and we would rather say so on the free 15-minute call than sign you up for work you do not need.

How the monthly flat fee works for an EDD audit

Many matters like this one run as a monthly flat-fee engagement: one number, agreed up front, that covers agency contact, deadlines, document responses and strategy until the matter resolves. It does not include the tax, penalties or interest the EDD assesses, or a CUIAB hearing or refund suit, which are scoped separately if the matter gets that far. The engagement ends when the auditor closes the file with a no-change letter, a refund or an assessment you accept, or when a Notice of Assessment issues and the petition is filed, at which point the appeal is quoted on its own.

Documents to gather

The EDD’s own audit information sheet lists the records the auditor will ask for, and eight items cover nearly every audit.

• The Inquiry Regarding Records, the questionnaire and every enclosure, with the envelope.
• DE 9 and DE 9C returns for every quarter in the audit period.
• Payroll registers and the federal Forms W-2, 941 and 940.
• Every 1099 form issued during the period and the DE 542 reports behind them.
• The general ledger and annual financial statements.
• Bank statements, check registers, canceled checks and cash payment records.
• Contracts and invoices for everyone paid outside payroll, and proof that they ran their own businesses.
• Articles of incorporation or the partnership agreement, and the city business license.

How far back does an EDD audit go?

Three years as a rule, meaning the twelve most recently completed calendar quarters. The auditor starts with a test year and expands to the whole period only when it shows differences. Where no returns were filed the EDD can assess eight years under section 1132 of the UIC, and it may ask you to sign a waiver extending the period when an audit runs long.

Do I have to fill out the EDD pre-audit questionnaire?

As a practical matter yes, because refusing does not stop the audit and the auditor will answer the questions from your filings and your workers instead. The choice you have is over time and precision: ask for an extension if the date is tight, then answer only what is asked. If you already sent it back, make sure the records you produce match what you wrote.

What happens at the EDD entrance interview?

The auditor explains the purpose and scope of the audit, asks how the business is organized and how its records are kept, and asks about the people paid for services; your designated representative can attend in your place. What is said there goes into the audit file alongside the questionnaire, so keep it short and factual.

Can my bookkeeper or payroll company handle the EDD audit?

They can produce the payroll numbers, but whether a worker was an employee is a legal question under the ABC test, and a bookkeeper’s offhand description of how the contractors were managed is evidence. The DE 48 decides who speaks for the business, and with any 1099 exposure that should be someone who knows what prongs B and C require.

Does the EDD share its audit findings with the Internal Revenue Service?

Yes, the EDD’s audit information sheet states that employment tax audit information is made available to the Internal Revenue Service (IRS) under an exchange agreement. A state reclassification can therefore be followed by a federal one.

How long does an EDD audit take?

In our experience a few months when the test year is clean and the records are organized, and most of a year when workers are reclassified and the findings are contested. It ends in one of four ways: a no-change letter, a refund or credit, an assessment, or both for different quarters.

Related pages

The other stages of an EDD audit:

• EDD audit attorney, the parent page
• A former contractor filed for unemployment
• The EDD worker classification finding
• The petition for reassessment
• CUIAB hearing
• EDD responsible person liability
• The ABC test in California
• The EDD audit process, from our guide