An audit by EDD can result in criminal charges. One of the prime reasons for EDD audits in 2021 is misclassified workers. Since AB_5 passed the confusion around which workers can still be paid as 1099s and which are required to be w-2s has many business owners jumping to put all workers on the payroll. Correctly classifying your workers is one of the biggest responsibilities that employers are faced with. Not only does it determine the benefits and compensation received by workers, but it can trigger an audit by EDD, a referral to IRS and the possibility of insurance fraud charges for failure to provide workers compensation insurance.
Can a payroll tax discrepancy cause an EDD audit?
The short answer is yes. Any financial irregularity can flag your account for an audit. If your business is paying workers that are not reported as a 1099 or W2, for example they’re paid in cash and you are not maintaining record of their payroll and payments, EDD may assess a fraud penalty and open a criminal investigation. Additionally, if your 1099 contractors are misclassified and should be classified as W2 employees, it likely means you also aren’t paying for workers’ compensation insurance, which could land you in trouble for insurance fraud.
What is more common are investigations of construction contractors who hire unlicensed workers. These investigations involve the Contractors State License Board (CSLB). A case can start with either CSLB or EDD and the two typically join forces and work together. If CSLB or EDD find misclassified and unlicensed workers, the cases will then be referred to the District Attorney’s Office in your city for potential criminal prosecution. These cases typically include workers’ compensation insurance fraud because your company did not have workers’ compensation insurance to cover these workers.
Filing in correct returns can be catastrophic for a busienss not only because of the refiling, work and stress of an audit but also because of the cost of fines and fees to lawyers. The best way to avoid audits is to file correctly, classify your workers correctly and seek the advice of professionals as you navigate the tempestuous waters of tax compliance.
Need a refresher on the 1099 vs w-2 rules: