How do I beat the EDD at their own game? So, beating the EDD at their own game is very tough because California, with the passage of AB5, has essentially regulated independent contractors outside of California. In order to be in a true independent contractor relationships, you need to either fall under the definition of AB5 or be engaged in a true business-to-business relationship where the person isn’t involved in being integral to the generation of your revenue.
So for example, I’m a law firm in California and I contract with a bookkeeper or a video production company. That is a bona fide independent contractor relationship. But the reality of the situation is if you come under a payroll tax audit and you have independent contractors in California, which is the subject matter for most payroll tax audits, it’s going to be difficult to beat the EDD because the EDD is locked on this issue and they know exactly what they’re looking for.
With that said, there are some tactics that you can use during the course of the audit to help you out. The first thing that I would recommend is of your independent contractors, separating people out by job category and by what these people do. So this may be a situation where you just have one class of workers, and if so, the strategy will not work for you. But to the extent that you employ multiple independent contractors, and they do multiple things, you want to try and bifurcate them into different buckets. Then within each bucket, you want to relate your level of risk. Certain buckets, you know you’re probably not going to be able to get past the owner. These are people that look like employees. They maybe students. They may be lower skilled workers, whatever they are. But there’s certain buckets that are probably going to be on the fence. And then there may be other buckets that are completely and totally an independent contractor relationship.
So by segregating this into buckets, you’re going to look at what your exposure is in different categories. And the key with beating the EDD at their own game is not necessarily to get out of the audit unscathed, but to get out with as little liability as possible. So there’s no harm in conceding to the independent contractors you know are going to get reclassified ahead of time.
So if you offer that up to the auditor, it’ll make things a lot easier. Then when it comes to the independent contractors that are on the feds, anything that you can do to establish those people as true independent contractors, you want to do that. Do you look at their LinkedIn? Can you see their LinkedIn profiles? Do they have insurance? Do they have a business card? Do they maintain their own websites? Do they advertise themselves? What do these independent contractors do to maintain their own business? All of that is very, very important. So that’s really how you beat the EDD in these situations.
The other way you beat the EDD is through the application of penalties. So the EDD is very severe when it comes to the penalty structure for misclassifying workers or for not filing the appropriate payroll tax returns. Even informational returns. You know, we’ve seen situations in our firm where we’ll have an amount of taxes due and the penalties will be five times or more in excess of the amount of tax.
So it’s really important that when you go into these audits, that you focus on beating the penalties as much as you do, beating the tax. So by developing a narrative at the beginning of the law, by defeating willfulness, by removing yourself from some of these harsher penalties, you’ll do a lot better for yourself. The actual tax itself, when you look at it from a payroll tax perspective in California, isn’t that much. So even workers with a pretty high payroll aren’t paying that much in actual tax, particularly if you have workers that are filing their own returns and paying their personal income taxes, because then you can get a debate it.
But the long and the short of it is, that’s how you beat the EDD at their own game. You go on it to strategically, you go in trying to mitigate your risk, and you go in trying to mitigate any penalties that are associated with that. And that’s how you can be successful in an EDD audit.