Businesses in San Francisco face a very strict and complex regulatory system. Two of the most consequential of these are audits by either the Employment Development Department (EDD) or the Franchise Tax Board (FTB). These agencies each focus on different issues and use different methods to do their investigations. Knowing how they work, and how to prepare for an audit, can make a big difference for a California employer.
At Weed Law Group, PC, our California business law attorneys are here to help. We assist you with compliance to stay ahead of the game, or protect your rights during an active audit.
What Is an EDD Audit?
An EDD audit examines whether a business has properly handled payroll-related obligations, including:
- Worker classification (employee vs. independent contractor)
- Payroll tax withholding and remittance
- Unemployment insurance contributions
- Disability insurance and paid family leave deductions
- Compliance with wage reporting requirements
EDD audits often arise in industries with large contractor workforces, such as tech, construction, hospitality, transportation, and professional services.
Common EDD audit triggers include:
- A worker filing for unemployment benefits
- A contractor filing a wage claim
- Mismatched or missing payroll tax filings
- Information sharing from the IRS or other agencies
- Random selection
EDD auditors frequently scrutinize whether workers labeled as contractors should legally be employees under California’s strict ABC test, which is embedded in state labor and tax law. Misclassification findings can lead to back taxes, penalties, interest, and mandatory reclassification.
What Is an FTB Audit?
An FTB audit focuses on income tax compliance, including:
- Corporate income tax returns
- Pass-through entity filings (LLCs, S-corps, partnerships)
- Personal income tax returns for business owners
- Apportionment of income for multistate businesses
- Deduction and credit eligibility
- Underreported income or overstated expenses
Common FTB audit triggers include:
- Large changes in income year-over-year
- High-value capital gains or equity events
- Schedule C or pass-through business losses
- Residency questions (especially for individuals moving in or out of California)
- IRS audit referrals
- Filing inconsistencies
FTB audits can be highly document-intensive, requiring detailed proof of income, expenses, residency, and business activity.
Key Differences Between EDD and FTB Audits
Although both agencies enforce California law, their audits are also very different:
1. Purpose of the Audit
- EDD: Ensures proper payroll tax withholding and worker classification.
- FTB: Ensures accurate income tax reporting and payment.
2. Who Is Audited
- EDD: Employers, gig-economy platforms, and businesses using contractors.
- FTB: Individuals, corporations, LLCs, partnerships, and pass-through entities.
3. Core Issues
- EDD: Employee vs. contractor status, payroll tax compliance.
- FTB: Income reporting, deductions, residency, apportionment.
4. Audit Methods
- EDD: Interviews workers, reviews contracts, analyzes job duties.
- FTB: Reviews tax returns, bank records, financial statements, equity documentation.
5. Penalties
- EDD: Back payroll taxes, penalties for misclassification, interest.
- FTB: Additional tax assessments, accuracy penalties, underpayment interest.
Why Bay Area Businesses Face Higher Audit Risk
The Bay Area’s economic landscape creates unique audit exposure:
- High contractor usage in tech, creative industries, and construction
- Complex compensation structures, including equity and bonuses
- Frequent interstate moves among tech workers
- Rapid startup growth, often outpacing compliance systems
- High income levels, which attract closer scrutiny
Both agencies also share information with the IRS and with each other, meaning an issue in one area can trigger a second audit.
How to Prepare for Each Type of Audit
EDD Audit Preparation
- Review contractor agreements and job duties under the ABC test.
- Ensure payroll records, wage statements, and tax filings are complete.
- Confirm unemployment insurance and disability insurance contributions.
- Maintain clear documentation showing why each worker is classified as employee or contractor.
FTB Audit Preparation
- Organize tax returns, financial statements, and supporting documents.
- Maintain proof of residency if you split time between states.
- Document business expenses thoroughly.
- Keep detailed records of equity compensation and capital gains.
Know How EDD and FTB Audits Can Impact Your San Francisco Business
Either audit can seem intimidating, but with the right legal counsel by your side you can move forward confidently.
Our team at Weed Law Group, PC are ready to help with your needs. Contact us today for a consultation.