Do You Know the EDD? A Guide for California Employers

Posted on April 11, 2025

Navigating California’s complex employment laws is challenging for many business owners and HR professionals. The California Employment Development Department (EDD) is a key agency enforcing these regulations. While its role is often misunderstood, the EDD has a powerful influence over worker classification, payroll taxes, and unemployment insurance.

Recently, the EDD has ramped up audits and enforcement efforts, mainly focusing on misclassifying employees as independent contractors—a trend that could have significant implications for California businesses. Understanding the EDD’s function, its audits, and how to remain compliant is crucial to protecting your business from financial and legal risks.

Understanding the EDD

The Employment Development Department (EDD) is a key government agency responsible for administering California’s employment laws. Its primary functions include:

The ABC Test

One of the pivotal frameworks used by the EDD to determine whether a worker is an employee or an independent contractor is the ABC Test. This test was established under California’s Assembly Bill 5 (AB 5) and serves as a strict standard for worker classification. To classify a worker as an independent contractor, all three of the following conditions must be met:

1. A: The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact.
2. B: The worker performs work outside the usual course of the hiring entity’s business.
3. C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

If a business fails to meet these criteria, the worker is presumed to be an employee under California law. Understanding the ABC Test is critical for companies, as misclassification can lead to audits, fines, and penalties imposed by the EDD. Businesses can ensure compliance and mitigate risks by carefully analyzing each worker’s role through this framework.

• Payroll Taxes: Overseeing the collection of payroll taxes for unemployment insurance, disability insurance, employment training tax, and employee-paid personal income tax.
• Employment Compliance: Enforcing regulations to ensure businesses comply with California’s labor laws.
• Unemployment Insurance Benefits: Managing the state’s unemployment insurance program.

The EDD’s scope extends to investigating worker classification issues and ensuring businesses pay state employment taxes appropriately. Failure to meet EDD requirements can lead to significant penalties for employers.

Looking to strengthen your HR infrastructure and ensure you’re protected in California? Contact EQHR Solutions to learn more.

The Rising Trend of EDD Audits

EDD audits targeting California employers are increasing, focusing on worker misclassification. This surge is fueled by several factors, including the state’s budgetary needs and new worker classification standards implemented in recent years.

Key Elements of an EDD Audit

An EDD audit typically begins with a notification letter sent to the employer. This letter outlines the scope of the audit and requests specific payroll records, tax filings, and documentation related to worker classification. Auditors will closely examine whether businesses have appropriately classified workers as independent contractors or employees based on guidelines established by California law, particularly the ABC test.

Additionally, the audit may assess whether the employer has properly reported wages, withheld taxes, and contributed to unemployment insurance, disability insurance, and other state-mandated programs. Employers should be prepared to provide detailed records, such as invoices, contracts, and timekeeping documentation, to substantiate their compliance.

Failure to cooperate or discrepancies uncovered during an audit can result in back taxes, penalties, and interest assessments. Therefore, understanding the key elements of an EDD audit is crucial for businesses aiming to mitigate potential liabilities.

Many businesses misclassify workers as independent contractors to avoid paying payroll taxes and offering benefits. However, these misclassifications can trigger audits, resulting in substantial finances, penalties, and back-tax payments.

Common Triggers for EDD Audits

• A high number of independent contractors compared to employees on payroll.
• Filing an Independent Contractor Form (1099-NEC) that appears inconsistent with a worker’s actual role.
• Worker Complaints from individuals claiming misclassification.
• Unemployment Insurance Claims filed by workers categorized as independent contractors.
• A whistleblower complaint or a worker filing for unemployment benefits.
• Filing discrepancies in payroll tax reports or inconsistencies in reported wages.
• Late or missing payroll tax deposits.
• Participation in industries with a history of worker misclassification issues, such as construction or gig-based services.
• Receiving an information-sharing report from the IRS or other government agencies.
• Random selection for audit under statewide compliance initiatives.

Liabilities and Penalties

Misclassifying an employee as an independent contractor can expose businesses to significant financial and legal risks. Common employer liabilities include:

• Payment of back taxes for unemployment insurance, state disability insurance, and income taxes not withheld.
• Fines and penalties issued for intentional misclassification or failure to comply with EDD rulings.
• Being held responsible for employee-related benefits such as overtime pay, meal breaks, and workers’ compensation.
• Legal fees and litigation costs arising from lawsuits filed by misclassified workers seeking owed wages or benefits.
• Reimbursement of expenses that employees may be entitled to, which were improperly denied under the misclassification.
• Potential criminal charges for willful tax evasion or fraud in extreme cases of intentional misclassification.
• Damage to company reputation, impacting relationships with clients, partners, and future hires.

Staying informed about worker classification laws is critical for avoiding these severe consequences.

The ABC Test vs. the Borello Test

One of the most debated topics in California employment law is determining whether a worker is an independent contractor or an employee. Employers must rely on two main legal frameworks for this assessment—the ABC Test and the Borello Test.

The ABC Test

Under the ABC Test, a worker is considered an employee unless the employer can satisfy all three of the following conditions:

1. Autonomy: Workers must be free from control or direction in performing their work.
2. Business Scope: The work performed must be outside the usual course of the hiring entity’s business.
3. Independently Established Business: The worker must be engaged in an independently established trade, occupation, or business of their own.

The ABC Test applies broadly, particularly under California’s AB5 legislation, but specific exceptions exist.

The Borello Test

The Borello Test is a more flexible, multifactor approach considering numerous elements to determine a worker’s employment status. It is used in certain cases where the ABC Test exemptions apply, such as in the professions of real estate agents, doctors, and some freelance writers.

Employers must understand which test applies to their industry and specific worker roles.

Conducting Internal Classification Audits

Proactively conducting internal audits is one of the best ways to ensure compliance with the EDD’s classification standards. Here’s a step-by-step guide to help your business avoid misclassification pitfalls:

1. Review Worker Roles

• Examine all current independent contractors and assess their duties based on the ABC or Borello Test as applicable.
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2. Check Contracts

• Ensure your independent contractor agreements clearly outline the relationship and define the nature of the work.

3. Analyze Payroll Records

• Verify that payroll taxes are accurately calculated for employees and not excluded for misclassified workers.

4. Rectify Misclassifications

• If you discover misclassified workers, consider reclassifying them as employees immediately. When necessary, back-pay any outstanding wages or taxes.

5. Maintain Documentation

• Keep clear records of your employment classifications, independent contractor agreements, and reasoning for classification decisions.

Seeking Professional Guidance

Given the complexities of worker classification laws, seeking professional guidance can be invaluable. Legal experts, HR consultants like eqHR Solutions www.eqhrsolutions.com, and payroll specialists can all help your business by:

• Ensuring compliance with the ABC and Borello Tests.
• Assisting with internal audits and documentation.
• Representing your business during EDD audits or legal disputes.

Proactively consulting professionals like EQHR Solutions can help you mitigate risks, optimize tax strategies, and strengthen your HR practices.

Protect Your Business and Strengthen Your HR Infrastructure

California’s employment laws are some of the most complex in the nation, and the EDD is taking worker classification more seriously than ever. To safeguard your business from legal and financial risks:

• Understand the EDD’s role and its audit triggers.
• Familiarize yourself with the ABC Test and Borello Test.
• Conduct internal classification audits and correct any misclassifications.
• Partner with legal and HR professionals to ensure compliance.

Don’t leave your employment practices to chance—act now to protect your business and workforce.