The EDD has stepped up unemployment tax audits to police independent contractor misclassification. Many believe the EDD is pursuing these investigations to bolster its balance sheets due to its tax losses during the pandemic.

The EDD investigations are directed at companies that paid “independent contractors” on a 1099 basis in the last three years. The EDD commences these investigations by sending targeted businesses a “Inquiry Regarding Records” letter and/or a “Preaudit Questionnaire” and an “Information Sheet: Employment Tax Audit Process.” The investigation is focused on whether a company misclassified an employee as an independent contractor in a manner that the company owes contributions and taxes for the misclassified employees. If you receive one of the above-mentioned communications immediately contact your business legal counsel and your accountant.

Employers must withhold certain sums for employee contributions and taxes. However, for a worker classified as an independent contractor, no such contributions or taxes are withheld by the employer. The goal of these investigations, according to the EDD, is “to ensure that employers properly report all workers, wages, and contributions for Unemployment Insurance, State Disability Insurance, Employment Training Tax, and California Personal Income Tax withholding.”

The Preaudit Questionnaire requests a broad scope of data and information to “expedite the examination of [the Company’s] books and records.” It contains inquiries related to whom the company contracts with, what types of services they provide, the types of accounting system maintained, contact information for bookkeepers, etc., and a response to the questionnaire is required no later than 14 days after receipt.

After the EDD’s receipt of the completed Preaudit Questionnaire, it will conduct a telephone investigation of the company and its bookkeepers. The EDD will ask about the operation and organization of the business and accounting records. The EDD auditor will then review the company’s books and records to: (1) verify the business ownership and type of entity (sole proprietorship, partnership, corporation, etc.); (2) verify that all individuals paid for services have been properly classified as either employees or independent contractors in accordance with the provisions of the California Unemployment Insurance Code (“CUIC”) and the common law test as applied by the State Supreme Court; and (3) discuss any questionable payments made for personal services and the nature of the working relationship(s) between the company and the worker(s). With additional input from the company and discussion(s) with the worker(s), the auditor will determine whether the worker(s) are employees or independent contractors.

After review of the company’s records, the EDD will send interview requests to workers paid as independent contractors to assist the EDD investigation to determine whether the company misclassified workers as independent contractors.

If the company is selected for a “complete audit” – something that is presently more likely than not – the following “tests” will be conducted by the EDD: (1) verification that the company’s acknowledged gross wages and taxable wages have been properly reported; and (2) verification that the company has correctly withheld and reported personal income tax for wages paid to employees.

Thereafter, the EDD auditor will arrange for an exit interview to review the audit findings and to attempt to resolve any disputed issues. If a company does not reach an agreement with the auditor, it may then request a pre-assessment conference with the supervisor of the auditor.

The audit can result in no action, a credit paid to the employer, or an “assessment” for underpayments.

A company may appeal an assessment under the Employer’s Bill of Rights. The company may petition the California Unemployment Insurance Appeals Board for a hearing before an Administrative Law Judge.

It is presently uncertain whether the EDD has or will refer investigations to the Labor Commissioner for enforcement action based on employee misclassifications.

If your company receives an “Inquiry Regarding Records,” a “Preaudit Questionnaire,” or an “Information Sheet: Employment Tax Audit” from the EDD, immediately contact your business counsel and come up with a response plan. However, the time to act is before you receive an “Inquiry Regarding Records,” a “Preaudit Questionnaire,” or an “Information Sheet: Employment Tax Audit”. Contact business counsel now to review your records now to determine whether any workers may be at risk of having been misclassified. The company should ensure it has a signed contractor agreement with each independent contractor, and that the independent contractor is a bona fide entity, not an
individual. Work with your legal counsel to calculate and pay any potential withholdings and taxes to avoid penalties in an assessment, in addition to reclassifying as employees those independent contractors who are determined to be misclassified.

The company should periodically conduct a misclassification audit to determine whether independent contractors are misclassified with the assistance of legal counsel, so the audit is subject to the attorney-client and attorney work product privileges. Don’t wait. The EDD has drastically stepped-up enforcement.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

A partial layoff can take several forms, including furloughs and a reduction in hours. Often, employers take these measures when business is slow, but they do not want to lose valuable employees and deplete their talent pool despite the lean times.

California requires an additional administrative hurdle for employees to collect unemployment benefits: form DE 2063. This form must be used in limited circumstances where full-time employees experience a reduction in earnings due to a lack of work. These unprecedented times have forced the EDD to take action and expedite these claims.

The EDD has announced that, due to the “sudden and immense impact of the COVID-19 pandemic on businesses and workers and the unprecedented demand for UI benefits,” employers should not use DE 2063 for the time being. Rather, the EDD recommends employers: (1) inform their working or laid-off employees to apply for UI benefits online for the fastest way to file; and (2) inform their employees that after they apply for UI benefits online and their claim is processed, to certify for continued benefits for every two-week period by logging into their UI Online account for the fastest way to certify and receive their benefit payments.

It is unclear how long this workaround will last, so it is important to stay alert, and understand that this is likely a limited exception. Nevertheless, it is a welcome, even if temporary, relief to both employers and employees who are already reeling from the impact of social distancing and mandatory shelter in place orders.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.

Employers facing business challenges that affect its workforce due to the COVID-19 virus pandemic might consider California’s Employment Development Department (EDD) Work Sharing Unemployment Insurance Program. The program is, in the EDD’s words, a “practical alternative to layoffs.” It allows, for example, an employer to reduce payroll by 20%, instead of laying off 20% of its workforce, and Unemployment Insurance would pay part of the difference in wages to affected employees.

To qualify for the program, an employer must have experienced a reduction in production, services, or other conditions that cause it to seek an alternative to layoffs. Certain terms and conditions apply:

• A minimum of two employees, comprising at least 10% of the regular workforce or a unit of the workforce, must be affected by a reduction in wages and hours worked.
• The reduction in weekly wages and hours worked must be at least 10%, not to exceed 60%.
• The employer must maintain employee health and retirement benefits under the same terms and conditions as prior to the reduction in hours and wages or to the same extent as for employees not participating in the plan.
• Corporate officers and major stockholders may not participate.

For employees to qualify to participate in the program they must:
• Be a part of the employer’s permanent regular workforce and not a leased, intermittent, temporary, or seasonal employee.
• Have qualifying wages in the base quarters used to establish a regular California UI claim, calculated by one of two alternative methods: the Standard Base Period and the Alternative Base Period. The Standard Base Period is the first four of the last five calendar quarters prior to filing the claim. The Alternative Base Period is the most recently completed four calendar quarters prior to filing the claim. If the employee has earned at least $1,300 in one-quarter of either type of Base Period, or $900 in one-quarter of either type of Base Period and total base period earnings are 1.25 times the highest quarter’s earnings, then the employee would qualify.
• Have completed a normal workweek (with no hour or wage reductions) before participating in Work Sharing.

An employer seeking to participate in the program must fill out the Work Sharing Plan Application, DE 8686, and submit to the EDD. These instructions and the Form can be found online here: https://www.edd.ca.gov/pdf_pub_ctr/de8686.pdf
The EDD Special Claims Office will send a letter of approval, one mail claim packet for each participating employee, and a ten-week supply of weekly certifications for each employee. The employer needs to issue these certifications to affected employees each week for the duration of the program. These forms must be mailed in weekly.

Benefits will also be paid weekly, proportionate to the percentage of reduction in hours and wages. The EDD provides this example: An employee who normally works five days a week for $500 is reduced to four days a week for $400. The Work Sharing benefits for this employee would be 20% of the benefits the employee would receive if unemployed. If maximum UI benefits for this employee would be $300, the employee would qualify for $60 in Work Sharing Benefits, bringing their weekly pay to $460.

The employer will be charged for Work Sharing Unemployment Insurance in the same manner as for regular UI benefits.

There may be some disadvantages for employers who utilize the program. The program can be administratively burdensome, because of the application and weekly certifications. Employers must periodically re-apply. There is also a potential increase in the employer’s unemployment insurance tax rate, but layoffs would have the same result if the laid-off employees seek unemployment insurance.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.