Part of being a business owner is filing and paying payroll taxes for your employees. In California, the Employment Development Department, or EDD, administers these taxes. In addition to receiving tax filings and payments, the EDD also identifies and investigates potential infractions of tax law.
What do you do if you develop tax problems and find yourself on the receiving end of an audit?
Who is the EDD and What Do They Do With Your Money?
The EDD, or Employment Development Department, is one of the largest state departments and is responsible for administering the payroll tax regulations for California businesses and individuals.
Payroll taxes administered by the EDD include the following:
- Employment Training Tax (ETT)
- Unemployment Insurance (UI)
- Personal Income Tax (PIT)
- State Disability Insurance (SDI)
Employment Training Tax provides funds for training employees in specifically targeted industries to make California more competitive in business. It is withheld at a rate of 0.1% with a taxable wage limit of $7,000 for 2016.
Unemployment Insurance, also taxed at a rate of 0.1% and a limit of $7,000, is part of a national program administered by the US Department of Labor to provide temporary payment to individuals who are unemployed through no fault of their own.
Both the ETT and the UI are employer contributions.
Personal Income Tax is levied on the income of California residents and income derived from the state by non-residents. The tax rate is determined by the employee’s Withholding Allowance Certificate (W-4 or DE 4). There is no taxable wage limit or maximum tax.
The EDD and Franchise Tax Board use these taxes to provide resources for state public services such as schools, public parks, roads, and health and human resources.
State Disability Insurance provides temporary benefit payments to workers who have non-work related disabilities and also is the source of Paid Family Leave benefits. The tax rate is 0.9%, with a wage limit of $106,742.
PIT and SDI are both withheld from employee wages and submitted by the employer to the EDD and IRS.
Most employers file and submit payroll taxes semi-weekly or monthly, although smaller businesses can pay on a quarterly basis. Very small employers can file once a year.
In 2017, AB 1245 will require all employers electronically to submit employment tax returns, wage reports, and payroll tax deposits to the EDD. Before then, payroll taxes can be submitted via electronic funds transfer, credit card, and direct deposit.
Calculations, Exceptions, and Exemptions
There are special rules for family members who work for you, non-profit organizations, and special exclusions. Some employment types are not subject to PIT withholding, but wages may still be reportable.
People receiving work-relief or work-training financed by any government agency and inmates of a custodial or penal institution are exempted from ETT, UI, and SDI withholdings.
A business owner can apply for a waiver from paying payroll taxes due to reasonable cause, statutory exceptions, or undue hardship. Each waiver is considered on a case-by-case basis.
Calculating withholding can get tricky when you must take into account holidays, terminations, leaves of absence, and other delays. Communication between the HR benefits specialist and the payroll office is crucial for keeping tax withholding on track.
The EDD and the IRS Are Not Alike
The tax regulations in California are comparable to the federal tax rules but not identical. There are different rules pertaining to family leave and who is held responsible for non-payment of corporate employment taxes. There are also subtle differences in how each defines employee classification.
Where and When Problems Occur
Employee classification is the area that causes the most problems for business owners. Both the IRS and the EDD are very interested in whether a worker is classified as an employee or as an independent contractor.
An employer must withhold, file, and pay employment taxes for an employee, but not for an independent contractor. The EDD looks at the employer-employee relationship to determine classification. If a person who hires an individual to perform services has the right to exercise control over the manner, method, mode, and means of how the service is performed, the worker is an employee.
Late Filing and Payment
If you file or pay late for payroll taxes, you are out of compliance and will owe penalties and interest on the amount of tax you owe.
Miscalculations, Underpayment, and Changes to the Business
If you miscalculate taxes, you will still be assessed a penalty if you underpay. If you try to conceal the existence of a worker by paying in cash and failing to file a Form 1099, you are also in trouble.
Changes to the business, like closing or expanding, must also be reported for the appropriate amount of taxes to be calculated and submitted without fear of penalty.
The key to any audit requested by the EDD is to make certain all records submitted are relevant to the EDD. Any records that do not pertain to employment related issues are not relevant.
Documents that can be requested include:
- Check registers and stubs
- Bank statements and canceled checks
- General ledger and journal
- Annual financial statements
- Vouchers and pay out slips
- Forms 1099
The EDD can decide to audit if a worker makes the case that he or she is an employee rather than an independent contractor (typically found out when the employee tries to apply for unemployment insurance).
Other triggers for an audit include:
- Filing or paying late
- Errors in time records or other statement or documents
- Digital failures that cancel or delay payroll
Tax Problem Resolution
The best way to resolve tax problems is to pay the full amount along with any penalties and interest.
If you cannot pay the full amount, you may be able to negotiate a payment plan to pay off the balance. Pay as much as you can up front and pay the rest as soon as possible. Filing for bankruptcy will not resolve California payroll tax problems.
You can dispute the audit findings. Be aware that a worker can be an independent contractor under federal payroll tax law but an employee according to the EDD.
Hire an Attorney
If you want to dispute audit findings or have representation for the audit, hire an experienced California tax attorney as early as possible. California payroll tax audits and appeals are complicated processes that require knowledge of the state tax law and the EDD.
You definitely need a lawyer if you intend to appeal your case to an administrative judge if negotiations with the EDD do not bring resolution. An attorney will know how to develop witnesses and documentary evidence as well as properly file legal briefs.
Like any other tax, payroll and employment taxes can be difficult to understand. However, it is in your best interests to file and pay on time and in full to avoid penalties and interest.
If you are notified of the EDD’s intent to perform an audit, make sure you only present relevant documentation and consider hiring a tax attorney familiar with state tax law to represent you for the audit or in the case of a dispute.