What Happens If I Get An EDD Audit?

If you run a business in California, you’ve probably heard of the Employment Development Department (EDD). This is a tax agency responsible for managing the accounting and processes of the state’s employment taxes. The EDD also conducts audits of businesses to ensure they are following the state regulations. This means as a business owner, it’s up to you to stay up to date with the requirements and have current records of your finances.

Owning a business comes with a lot of responsibility, especially when it comes to managing finances. Keeping accurate financial records and proper bookkeeping is an important part of a business and can help prepare you in case the EDD audits your business.

The CA EDD isn’t interested in investigating you; rather they are just trying to make sure that taxpayers are following the tax rules and regulations. If you do receive an EDD audits notice in the mail, don’t fret. You can be fully prepared for the audit, including the process and requirements.  

What’s an audit?

An audit is a fancy way of saying an examination of financial documents. This can be done internally, by another department, or externally by an independent auditor, firm or the IRS. Audits are conducted to check whether the financial records accurately reflect the transactions they claim to reflect. You might receive an IRS audit based on your 1040 tax return, but that’s a whole different story for another day.

Some financial records checked during an audit are cash flow statements, balance sheets and income statements. Audits help combat fraud and hold companies accountable for their finances.

What’s an EDD audit?

The California EDD audit happens when they suspect a company is not complying with payroll regulations. It’s EDD’s job to enforce payroll collections and conduct audits on businesses.

Usually, when the audit occurs, they’re looking to see if the business has classified their employees properly since this determines how much payroll taxes the employer pays.

The best way to avoid an audit is to correctly classify all of your workers on payroll taxes. California doesn’t take payroll taxes lightly. It does pay more in federal payroll taxes than any other state, after all.

Does EDD audit individuals?

Thankfully, the commission doesn’t audit individuals. This type of audit is only for businesses in California.

What triggers an EDD benefit audit?

Usually, the EDD doesn’t randomly select a business to audit. Instead, something has to trigger the EDD to request an audit.

Independent contractors filing unemployment

The most common reason an EDD audit occurs is when a worker classified as an independent contractor applies for unemployment benefits.  When the worker tries to apply for unemployment, it triggers the CA EDD to perform an audit.

Late filing of payroll tax returns

Failing to pay or file payroll tax returns can trigger an audit. Plus, you’ll be hit with penalty and interest charges.

EDD verification process

Sometimes, the EDD will select businesses randomly for a verification audit.

Failing to pay wages on time

When California-based employees don’t receive their wages on time, they usually report this to the EDD. This triggers an investigation by the EDD to verify if the complaint holds true.

Several things can trigger an EDD Tax Audit including independent contractors filing unemployment, late filing of payroll tax returns, the EDD verification process, and failing to pay wages on time.

What’s the process for the Edd audit?

There are a certain set of steps involved when it comes to the EDD audit.

EDD mails audit notice

You’ll receive a notice in the mail from EDD requesting an audit. The notice contains a list of documents you’re required to submit, and the reason they’re requesting the audit. You can send the requested documents and evidence back to them in the mail, too.

EDD Interview

After sending the audit notice, the EDD will call you for an entrance interview to brief you on the reasons for the audit .It might be best to speak to a financial advisor or tax lawyer before attending the interview, so you’re fully prepared to answer any questions they might have.

Reviewing financial documents

All the financial documents you submitted will be under review at this stage. The documents include your business verification, bank statements, 1099 forms and checkbooks.  

Request for additional clarification

The commission may request additional documents from the company if they find inconsistencies with the financial records. They may also request employee classification records and payroll tracking information.

How to fill out the questionnaire before the EDD interview

If the CA EDD decides to audit your business, they will first send you a questionnaire. The questionnaire requests information about your business and provides the auditors with accurate information so they can develop an audit plan.

Description of the business

This includes the nature of your business and your business model.

Services provided

This is for the service you provide and the number of employees in your company.

Accounting

The bookkeeping and accounting methods you use are important for the auditors to understand how your business manages finances.

Employee Benefits

If you provide any benefits to your employees, you’ll need to list them.

EDD audit penalties

When it comes to fines, the CA EDD determines the amount based on how much time has passed. There’s a 2% penalty for deposits made five days late and 5% for payments 6-15 days late. If your payment surpasses 15 days, the penalty is 10%.

If you get a notification in the mail from the IRS for failing to pay within 15 days things start to get even more serious. Let’s say you can’t pay it within 10 days, you’ll be charged a 15% penalty. It’s best to use the EDD just pay it option to avoid any late penalties. You could even get a fine of $5,000 if you misclassify an employee.  

Let’s face it, no one likes to be audited. It can feel like an investigation and might even cause you to lose sleep at night. Rest assured, preparing yourself in case of an audit is always the best course of action. You can always ask for CPA advice on a platform like FlyFin, which can help ease your worries and answer your pressing questions. So if an audit does come your way, you’ll be fully equipped with everything you need to pass it smoothly.