What Triggers an EDD Payroll Tax Audit?

The Employment Development Department (EDD) oversees payroll tax enforcement in California — and if you’re an employer who hires, pays, or contracts anyone, you're on their radar.

An EDD payroll tax audit can be triggered even if you think you’re doing everything right. These audits are common, disruptive, and sometimes lead to large retroactive tax bills, penalties, and referrals to other agencies.

In this article, we’ll explain:

• The most common audit triggers
• What the EDD is really looking for
• How to avoid being flagged in the first place

Already dealing with an EDD issue? Start with our guide on California state tax enforcement defense.

What Is the EDD Looking For?

The EDD enforces California’s payroll tax rules, including:

• Unemployment Insurance (UI)
• State Disability Insurance (SDI)
• Employment Training Tax (ETT)
• Personal Income Tax (PIT) withholdings

An audit usually involves a 3-year lookback and seeks to determine:

• Whether workers were misclassified
• Whether all wages and payments were reported
• Whether payroll tax was filed and paid correctly

Top Triggers for an EDD Payroll Tax Audit

1. 1099 vs. W-2 Misclassification

This is the #1 trigger. If you pay contractors who should’ve been employees, EDD will reclassify them — and bill you for back payroll taxes.

Red flags include:

• Contractors working set schedules
• Contractors using your equipment
• Contractors with no separate business entity

2. Disgruntled Worker Complaints

If a former worker files for unemployment and claims they were misclassified, EDD opens a case automatically — even without other indicators.

This is the fastest path from “everything’s fine” to “you’re under audit.”

3. Payroll Tax Filing Gaps

Late, inconsistent, or missing filings (DE 9s) often result in desk reviews or full audits — especially if:

• You paid wages but didn’t file
• Your filings don’t match wage amounts on W-2s
• You skipped filing in low-revenue quarters

4. Business Entity Changes

Changing from sole proprietor to LLC, or LLC to S corp, can trigger EDD reviews — especially if:

• You stopped reporting payroll
• You hired yourself as a contractor
• You closed and reopened under a different EIN

5. High Contractor Payment Volumes

If you issue lots of 1099s — especially over $50K–$100K/year — you may be flagged.

EDD often asks:

• Were these true independent contractors?
• Did you supervise or direct their work?
• Did you provide their tools or materials?

6. Franchise Tax Board (FTB) or CDTFA Referrals

If you're already being audited by the Franchise Tax Board or CDTFA, you may be referred to the EDD automatically — especially if payroll tax inconsistencies show up.

What Happens in an EDD Audit?

You’ll receive an Audit Notification Letter, followed by a request for:

• Payroll records
• 1099s and W-2s
• Bank statements
• Worker classifications and job descriptions
• Payment ledgers

The audit may involve:

• Worker interviews
• Reconstruction of wages
• Estimates if records are missing or unclear

Penalties for Misclassification

If EDD reclassifies your contractors as employees, you could owe:

• Unpaid UI, SDI, ETT, and PIT
• 10–25% penalties
• Interest
• Trust fund recovery liability
• Potential referral to the IRS or CA Attorney General

🎯 Pro tip: Even one misclassified worker can trigger a full-blown audit of all your contractors over the lookback period.

How to Avoid an EDD Audit

✅ Properly classify workers using the ABC test and IRS common law standards
✅ File all payroll tax returns on time (DE 9, DE 9C, DE 34)
✅ Avoid paying yourself as a contractor if you're incorporated
✅ Document all independent contractor agreements
✅ Respond to FTB, CDTFA, or IRS inquiries promptly — don't let one agency hand you off to another

Why Work With Boulanger CPA

We help California employers:

• Respond to EDD audit notices
• Defend worker classification decisions
• Negotiate reduced assessments
• Coordinate overlapping audits with FTB and CDTFA
• Clean up prior-year filings and get back into compliance

Our clients include:

• S corps
• Contractors
• Startups
• Medical practices
• Real estate firms
• Home service businesses

Schedule a Payroll Tax Audit Strategy Call

If you’ve received an audit notice or suspect one is coming, now is the time to act.

📍 Based in Orange County. Serving clients statewide.
🖥 Virtual consultations available.

👉 Schedule your free audit strategy call

FAQ – EDD Payroll Tax Audits in California

📣 About the Author

Marc Boulanger, CPA is the founder of Boulanger CPA and Consulting PC, a boutique tax resolution firm based in Orange County, California and trusted by high-income individuals and business owners across Southern California.

He is the author of Defend What’s Yours: A California Taxpayer’s Guide to Beating the IRS and FTB at Their Own Game, available now on Amazon. The book offers a step-by-step plan for resolving IRS and FTB tax debt without losing your business, your home, or your peace of mind.

With over a decade of experience resolving high-stakes IRS and State tax matters, Marc brings strategic insight to complex cases involving wage garnishments, bank levies, unfiled returns, and six-figure tax debts. He is known for helping clients reduce or eliminate tax liabilities through expertly negotiated settlements and compliance plans.

Marc is a Certified Public Accountant licensed in California and Oklahoma and holds the designation of Certified Tax Representation Consultant. He is a member of the American Society of Tax Problem Solvers (ASTPS) — the national organization founded by the educators and practitioners who have trained thousands of CPAs, EAs, and tax attorneys in IRS representation strategy.

Every case is handled with discretion, proven methodology, and direct CPA-led representation — not call center scripts.

📍 Learn more at www.orangecounty.cpa or call (657) 218-5700.