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If you received notice from the EDD that your business is being audited, you should consult with an experienced tax attorney. If you don’t speak with an audit defense attorney, you may simply agree to whatever the EDD concludes and pay interest and penalties without understanding your rights. On the other hand, if you decide to hire an experienced tax attorney, you can rest assured that you’re taking every step possible to mitigate your payroll tax liability.
If your business received notice of an audit call audit defense attorney Jin Kim at (916) 299-9913 for a free consultation.
One of the most common pitfalls for small businesses is the incorrect classification of employees as independent contractors. When it comes to independent contractors, businesses are not required to withhold payroll taxes and remit those funds to the IRS and EDD. However, employers are required to do this for every employee on their payroll. It’s not hard to see why some businesses might be tempted to classify workers as independent contractors when they are arguably employees.
Small businesses and self-employed individuals are scrutinized more thoroughly by the IRS than many wage earners. There is a viewpoint within the IRS that small business or self-employed individuals are more likely to cheat on their taxes as they have more opportunities to underreport income, inflate business expenses, and misclassify workers. If you’ve complied with U.S. tax laws and classified your employees properly, there’s no need to be overly worried about a payroll tax audit. With that said, sometimes classifying your workers as employees or independent contractors is a judgment call that can leave you with payroll tax liability following an EDD audit.
Employee vs Independent Contractor
There are several indicators that a worker is an employee rather than an independent contractor for purposes of EDD classification. These criteria are:
- Control – You, as the employer, direct the worker as to the means and method of working. The employee doesn’t really have the freedom to use their discretion (but they may do so if the employer allows it).
- Tools and Equipment – Furnishing tools and equipment to the worker is a sign to the IRS that the person is an employee and not an independent contractor.
- Set Hours of Work – The employer requires the worker to be present and work at a particular time. The worker doesn’t have the freedom to choose his/her own hours of work.
Other criteria signify to the EDD or IRS that a person is an employee, but these are the most common. Remember, it’s not your point of view that is important if you’re undergoing an audit. You might see someone as an independent contractor, while the IRS or EDD may see the worker as an employee. It’s important to see it from the IRS & EDD’s perspective rather than your own.
On the other hand, several criteria indicate that a worker is indeed an independent contractor. They are as follows:
- The worker has the freedom to choose their own hours of work, and they’re free to hire assistants to assist them. An independent contractor may even subcontract the work, something which an employee isn’t allowed to do.
- The worker is paid by the job rather than receiving a regular salary. Payment by commission may also show that the worker is an independent contractor.
- The worker provides his or her own tools, materials, and equipment.
- The services of the worker are offered to the general public, and not just to one particular employer.
If these factors are present, then an employer may classify a worker as an independent contractor.
How You Can Protect Yourself From Employee Misclassification
Because the line between an employee and an independent contractor can be blurry, there are several ways for business owners to protect themselves.
- If you’re hiring an independent contractor, have it reduced in writing. A written contract can be proof that a person is an independent contractor, especially when the contract contains factors that point to an employer-independent contractor relationship.
- Ask that the independent contractor perform the job at their own place. Having the independent contractor work at your workplace may give rise to the incorrect presumption that they’re an employee.
- Require proof that the contractor is indeed reporting on their taxes the amount you pay them.
Tax Relief For Employee Misclassification
Sometimes an EDD audit results in the reclassification of independent contractors as employees with attendant payroll tax arrears. The assessed payroll tax liability may be substantial, and continued failure to collect and remit payroll taxes can result in termination of the business. However, businesses that have been assessed payroll tax liability do have tax relief options that can permit the continued operation of the business with sufficient cash flow. In general, installment agreements are a popular tax relief option for payroll tax liability as the cost of installment agreements is generally less than offers in compromise and they may be acquired when offers in compromise are not viable. To learn more about your best tax relief option for payroll tax liability call the Tax Law Office of Jin Kim at (916) 299-9913 for a free consultation.
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