Independent Contractor Compliance Blog

That’s correct: under the Unemployment Insurance Code 13052.5, if the EDD audits your company and decides you misclassified your consultants you will be assessed for their personal income tax withholding. Also, it is illegal for you to go back and attempt to collect the tax from the consultant after the fact.

The personal income tax (PIT) withholding rate that will be assessed has increased from 6% to 9.3%. That means on $100,000 of misclassified wages, your company will be assessed and liable for $9,300, plus penalty and interest. That is in addition to unemployment, disability and all the other payroll taxes the State of California collects.

You didn’t know companies who misclassified workers had to pay their personal income tax?

Both federal and state tax code provides that if an employer fails to withhold personal income taxes at the time payment is made then the employer becomes liable for the income tax. Tax audits are always looking in the past at least one to three years and sometimes longer. If an auditor decides retroactively you misclassified your independent contractors or consultants you will owe the personal income tax you should have withheld had you treated them as an employee.

That’s right!  You may have to pay their income taxes retroactively!

There is a way to get some relief

Both the IRS and EDD have procedures for relief of a portion of the misclassified worker’s personal income taxes. However, at both the state and federal levels there are some very specific and strict criteria that must be met in order to qualify for relief. Unfortunately many employers fail to meet these stringent criteria. If your company does not meet the criteria for relief it will be required to pay the entire amount of personal income tax the auditor decides you should have withheld.

Even if you are able to get relief for some of the personal income taxes, you must still pay the full amount of penalty and interest.

The odds are against you

In California last year less than 20% of the employers assessed for misclassified workers in an audit received a clearance from the Franchise Tax Board (FTB) to relieve them of the withholding taxes assessed. This means the FTB could not, or would not, verify the misclassified workers had properly reported and paid their personal income tax on the misclassified wages for at least 80% of the tax assessments made.

The EDD has a secondary procedure to help employers obtain some relief by obtaining an affidavit signed by the consultant, under the penalty of perjury, certifying the wages were properly reported and all taxes were paid. However, historically, this method does not relieve many employers either because the consultants are no longer available or will not sign the form.

This year, the EDD has a new option available, but the new process is still in the testing phase and the criteria are subject to very strict verifications. The program’s success is not known at this time.