When you’re a recruiter who offers contract staffing services, you are the employer of record. You are in charge of financial, legal, and administrative details for the contract workers. Part of your responsibility is correctly classifying the workers, and withholding and remitting employment taxes for contract employees.
If you don’t properly follow your responsibilities, you may be audited by the federal government. Depending on the results of the audit, you might owe back wages and taxes, penalties, and interest.
Recruiters in California face another audit threat: the Employment Development Department (EDD). The EDD can conduct payroll tax audits on any businesses operating in California.
What is an EDD audit?
The EDD conducts audits to ensure that businesses pay payroll taxes and employees receive their entitled benefit coverage. Basically, the audit checks to see if you classified workers correctly and finds out if you paid employment taxes.
The audit covers the 12 most recently completed calendar quarters, making up a total of three years. However, if you didn’t file any returns, the audit might cover a longer period of time.
What triggers an EDD audit?
Many things can cause an EDD audit. Generally, the EDD will conduct an audit if they are suspicious that your business might incorrectly be labeling workers or paying taxes.
Many times, an EDD audit is triggered when a worker who is listed as an independent contractor goes to claim unemployment benefits. Independent contractors cannot receive unemployment benefits, so their claim causes the EDD to be suspicious of your business. The EDD will suspect your business of misclassifying your contract workers.
The EDD audit process
If you are subject to an EDD audit, you will receive an audit notice. An auditor will perform an entrance interview. During the interview, the auditor will:
- Explain the audit’s purpose
- Explain the audit process
- Gather basic information about your business and accounting records
- Answer your questions
During the audit, the auditor will look at your records. The records you must provide depend on how extensive your audit is. Documents you might need to provide include:
- Check registers, check stubs, canceled checks, and bank statements
- General ledger and general journal
- Annual financial statements
- Cash payment records
- Ownership verification
- Federal and state income tax returns
- Form 1099 and federal information returns
- Payroll records
- Federal and state employment tax reports
The auditor will verify your business’s ownership and type of entity. They will make sure you properly classified all your contract workers as either an independent contractor or an employee. They will look at payments made, services performed, and your relationship with the worker.
You might be selected for a complete audit where the auditor looks at even more information. If this happens, the auditor will verify that you correctly reported gross wages and taxable wages. They will also check to see if you properly withheld and reported income tax.
After the audit, there will be an exit interview. The auditor will tell you the results of the audit. The audit will end in one of four ways:
- No differences were found
- You made an overpayment and will receive a credit or refund
- You made an underpayment and the difference will be assessed
- You made both an overpayment and underpayment
The EDD shares its audit information with the IRS, so the IRS can use the findings as well
Ways to prevent an EDD audit
No one wants to go through an EDD audit or experience EDD audit penalties. There are things you can do to help protect yourself from one.
Make sure your contract workers are classified correctly. If you aren’t sure whether or not a worker is a contract basis employee or an independent contractor, the IRS can help. You can fill out Form SS-8 to ask the IRS to determine the worker’s status for you. The Form SS-8 determination tells you exactly how you should classify the worker.
Once you know how your contract workers are classified, you must pay them correctly. You must properly pay wages and remit and file taxes. If the workers are employees, you must follow FLSA rules on minimum wage and overtime. You must withhold and remit income taxes, Social Security tax, and Medicare tax. You need to file employment tax forms on time, too. There are also other employment laws and employer-only taxes you must follow.
Even if you follow the rules, you might still be subject to an EDD audit. But, hopefully, the EDD won’t find anything wrong.
You can use employer of record services to help you remain compliant. Top Echelon’s Recruitment Back-Office Solutions will become the employer of record, taking the legal, financial, and administrative responsibilities off of you. Top Echelon will make sure contract workers are classified correctly and take care of payroll and taxes.