The EDD and you: worker classification, SUTA dumping and audits among issues to watch in '07.

It's tax season, the only time of year during which some CPAs actually see some clients. So this might be your only opportunity to discuss some important issues from the Employment Development Department.

MISCLASSIFICATION OF WORKERS

The nature of work is changing rapidly in this country, so it's not surprising that the biggest issue facing businesses today is the proper classification of workers as either employees or independent contractors.

More than 40 percent of EDD audits result from workers filing claims for unemployment insurance benefits when no wages were paid by the business while the worker was employed there.

In such cases, the EDD will open an audit to determine if the business has misclassified the worker and will scrutinize all of the business' independent contractors--not just the one who inappropriately filed for unemployment insurance benefits. If the business has misclassified workers, the EDD has the authority to audit the last three years if quarterly DE-6s were filed and to audit the last eight years if not filed.

WHAT CAUSES EDD AUDITS?

Various situations that can trigger an EDD audit. One of the biggest reasons is that the EDD identifies a particular industry that it believes is misclassifying workers and audits businesses in that industry.

For example, the EDD is auditing nearly all companies in the courier industry that are paying workers as independent contractors rather than employees. As of Nov. 30, 2006, 353 businesses in that industry have been audited. Of those, 254 have been assessed a total of $40.8 million in tax, interest and penalties.

In the current fiscal year, about 400 more courier businesses will be audited. In some cases, the EDD is working with criminal investigative agencies at city, county, state and even federal levels to pursue criminal prosecution. Also, the EDD has joined other agencies, such as the IRS, Franchise Tax Board, Department of Industrial Relations, Department of Justice, Department of Insurance and State Compensation Insurance Fund (SCIF) in pursuing these audits.

The EDD receives audit results from the IRS, FTB, BOE and SCIF and sometimes uses them to determine if an EDD audit is necessary. The EDD also may review Form 1099 filings for potential abuses by businesses.

The good and bad news is that lack of sufficient funding from the Legislature prohibits the EDD from conducting all of the audits for which they get leads. What does this mean? Since the EDD can't pursue all its leads, there's a chance that businesses that don't correctly classify workers won't be caught. And that means the state loses tax dollars and workers do not receive the benefits to which they are entitled.

CPAs are advised to inform their clients to properly classify their workers because if an audit occurs, it has the potential of ruining business.

ONLINE BUSINESS REGISTRATION

Sometime this year, the EDD will make available EZREG, which will allow businesses to register with the EDD online.

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Established businesses will be able to update their addresses, notify the EDD when they no longer have employees or that they are out of business. In addition, most businesses will be able to receive their EDD account number and tax rates through this service.

ONLINE FILING OF DE-6S

The EDD also is expected this year to implement the Fed/State Employment Taxes (FSET) program, which will allow employers to submit their DE-6s online as a file attachment.

FSET was developed by several states, the IRS and some software vendors. Although the initial implementation only will accept the DE-6, the EDD plans to expand the program to accept other forms.

EDD COMPUTER SYSTEM UPGRADE

The EDD is beginning to upgrade its computer systems similar to the systems used by the FTB and BOE, which use current tax collection and data retrieval technologies.

The new system is expected to generate about $583 million in additional revenue over the next 10 years, with ongoing additional revenue of $70 million beginning in about 2012, according to the EDD.

Though the specifics are still being worked out, the system is expected to identify businesses that are incorrectly classifying workers; allow employers online access to their payment information; set up payment plans for outstanding balances; and collect worker back wages and associated penalties that are due to the state Department of Industrial Relations.

Full implementation is expected in December 2010.

PAID FAMILY LEAVE

The Paid Family Leave program began in July 2004 so employees could take time off from work to take care of a relative needing assistance or to bond with a new child. The program has been slowly growing since implementation, with about 139,000 claims filed the first 10 months of 2006 out of about 17 million workers. Annually, a little less than 1 percent of the workers are using the program. Of those taking Paid Family Leave, the average time off has been a little more than 5 weeks.

As a reminder, employees pay for the benefits via State Disability Insurance withheld from their paychecks. When they do receive benefits, they are taxable for federal purposes, but not for California.

For more information on the program, visit www.edd.ca.gov/fleclaimpfl.htm and www.edd.ca.gov/eddquickstats.asp.

STATE UNEMPLOYMENT TAX ACT (SUTA) DUMPING

The U.S. Department of Labor several years ago alerted states to the issue that businesses were incorrectly transferring their wages from high-rated employer accounts for SUT to lower-rated employer accounts.

There are numerous variations on the tax avoidance schemes, but all include obtaining multiple employer account numbers and dumping or socializing negative employer reserve account balances to be paid by other businesses.

To date, the EDD has assessed in excess of $200 million in additional taxes, penalties and interest against SUTA-dumping businesses and has been able to collect in excess of $150 million.

CPAs should advise their clients against any form of SUTA dumping as it can cause civil and criminal penalties against the business and anyone who advises businesses to SUTA dump. The EDD provides examples of SUTA dumping at www.edd.ca.gov/taxrep/txueosd.htm.

THE UI FUND

In 2004, the California Unemployment Insurance Fund had to borrow from the federal government to pay UI benefits. Since then, the fund balance has slowly been increasing, but if the economy were to go into a recession, the fund may not have enough to pay benefits without having to borrow again from the federal government.

In 2004, there was some discussion--but no action--about changing the system of wage limits and wage rates. The fund has slowly built up to about $2.4 billion. While that may seem like enough, benefit payments were about $6.1 billion in the most recent downturn (in 2002). Couple that with the increase in the maximum weekly benefit from $330 in 2002 to $450 today, and it seems reasonable to conclude that more dollars would be needed.

If the economy should take a turn for the worse, employers should be prepared for legislative requirements to pay more into the UI Fund by raising the wage limit or the UI tax rate.

For information on the UI Fund, go to www.edd.ca.gov/edd-uiforecast.pdf.

EDD COLLECTIONS OF CONTRACTORS

One issue that could affect construction clients is that Business and Professional Code Sec. 7145.5 allows the Contractors State License Board (CSLB) to place a hold on a contractor's license if the individual has an outstanding liability assessed by the board, DIR, EDD or FTB.

In 2006, Gov. Schwarzenegger signed AB 2456, which allows the CSLB to put a hold on every individual named on the license and prohibits the individuals from doing business under other licenses.

As a matter of policy, the EDD will not initiate a hold on a contractor's license when the debtor is in compliance with a payment arrangement.

So while you may wish to contest reclassification and tax liability issues with the EDD, you need to be aware of the licensing issues when advising your clients as the EDD could put them out of business by reporting them to CSLB if the tax liability is final and the business does not have an approved payment plan.

NEW EMPLOYEE, INDEPENDENT CONTRACTOR REPORTS

The California Legislature requires businesses to file reports with the EDD when hiring a new employee or when using the services of an independent contractor.

The EDD forwards this information to the Department of Social Services so it may check whether or not the workers are delinquent in child support payments. If so, the agency will send a garnishment to the business.

Some wonder why W2s or Form 1099s would not serve the same purpose. The issue is the timing of getting the information.

An independent contractor may no longer work with a certain business after that one job and thus a garnishment would do no good. For employees, they may move on after the beginning of the year and thus no payments are due them.

The state is motivated to collect delinquent child support because the custodial parent may be on, or have drawn in the past, welfare or other state benefits that could be paid back from the child support collections.

For information on New Hire Reporting, visit www.edd.ca.gov/taxrep/txner.htm; for IC Reporting, go to www.edd.ca.gov/taxrep/txicr.htm.

James C. Counts, CPA is owner of James C. Counts II, CPA in Hemet and is the CalCPA Committee on Taxation's liaison with the California Employment Development Department. You can reach him at james.counts.cpa@earthlink.net.

BY JAMES C. COUNTS II, CPA