A worker being treated as an independent contractor may seem like a simple paperwork decision. In California, it can become a payroll tax issue if the relationship does not meet the applicable worker-classification rules. Once an EDD audit begins, the records, contracts, payments, and actual working relationship can all come under review. Acting early can make a significant difference.
Why worker misclassification becomes an EDD problem
California generally treats a worker as an employee unless the applicable requirements for independent-contractor status are satisfied. For many workers, the ABC test applies. It generally requires the hiring business to establish that the worker is free from control, performs work outside the usual course of the business, and operates an independently established trade or business. Certain occupations and situations are subject to exceptions or a different test, such as the Borello multifactor test.
That is why simply having an independent-contractor agreement or issuing a Form 1099 does not automatically settle the question. The actual relationship matters.
What happens when EDD starts asking questions?
During an employment tax audit, EDD may examine how workers were classified, how they were paid, and what the working relationship looked like in practice. EDD audit guidelines specifically indicate that auditors gather documentation and ask employers why they believe a worker qualifies as an independent contractor. Employers are also given an opportunity to provide relevant information.
This is where legal guidance can be useful. An EDD audit lawyer can review the facts before an employer responds, identify potential classification problems, organize supporting records, and help address questions from the agency accurately.
What can an attorney review?
A proper review goes beyond the contractor agreement. It may include:
- Contracts and written agreements
- Invoices and payment records
- 1099 reporting
- Job descriptions and actual duties
- Who controlled the worker's schedule and methods
- Whether the worker served other businesses
- Business licenses and independent-business records
- Communications between the company and worker
- Payroll and employment tax records
The goal is to compare the documents with what actually happened. A mismatch between the written agreement and day-to-day working arrangement can become important during an audit.
Why waiting can make the situation harder
If EDD determines that workers were incorrectly classified, the consequences can extend beyond changing the worker's status. California EDD explains that an assessment for misclassified workers can create state payroll tax reporting and payment responsibilities. Back taxes, penalties, and interest may also become an issue.
EDD's audit program also examines worker classification as part of employment tax audits and can issue assessments for payroll taxes, penalties, and interest when appropriate.
There may also be reporting obligations involving independent contractors. For qualifying payments of $600 or more, California generally requires certain independent-contractor information to be reported to EDD within the applicable deadline.
What should a business do after discovering a mistake?
Do not destroy, alter, or backdate records. Instead, gather the relevant contracts, payment records, correspondence, tax filings, and details about how the workers actually performed their jobs.
Then have the classification reviewed. Depending on the circumstances, the business may need to correct payroll reporting, address past periods, respond to an EDD inquiry, or challenge a determination through the appropriate process.
It is also important to look beyond EDD. Worker classification can affect federal tax reporting and other employment obligations. For example, businesses dealing with broader federal tax matters may also need advice from an IRS tax attorney San Diego taxpayers can consult.
The main takeaway
Misclassification is easier to address when it is identified early. A business should not wait for an EDD assessment to discover that its contractor arrangements have problems. Reviewing the relationship, preserving records, correcting genuine errors, and responding carefully to EDD can help prevent a manageable mistake from becoming a much larger tax dispute.
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