ESD Audits: What They Are, How To Prepare, And Best Practices For Employers | Perkins Coie


Overview of ESD audits

The Washington State Employment Security Department (ESD) reviews Washington employers’ records to confirm that wages and hours are reported correctly and to ensure that state unemployment insurance laws and regulations are being followed.

The US Department of Labor (DOL) requires ESD to conduct annual compliance audits, and ESD selects employers to be audited based on whether: (1) the employer has a pattern of inconsistent reporting; (2) the employer is in an industry with a historically high level of non-compliance; (3) the employer has transferred ownership or reclassified the type of business; (4) every citizen has reported fraud; or (5) the employer is selected at random by a computer (approximately 10% of the total audits). In particular, the selection for an audit not mean that an employer has violated a law or regulation.

If an employer is selected for an exam, ESD’s examiners will contact the employer by phone, email or letter to inform the employer of the upcoming exam; identify the records to be reviewed; and will set a mutually agreed date, place and time for the audit to be conducted. In addition, ESD will send the employer a letter of confirmation of appointment, a pre-assessment questionnaire and a required record checklist that needs to be completed.

During the audit, ESD auditors will perform a variety of functions including finding evidence on unreported employees, casual workers, independent contractors, and other workers who provide personal labor; Example of salary and time records to compare with wages and hours reported to ESD; and review the nature of the business and that the correct tax rate is assigned to a new employer. ESD auditors typically require records dating back three years, but if an auditor finds questionable business practices, the exam can be extended. (RCW 50.24.190). In particular, ESD auditors typically check: (1) payroll, bookkeeping, and employee time and attendance; (2) Company Proof of Ownership and Licenses; (3) bank records, financial statements, check registers, ledgers and invoices; (4) state and federal tax records, including IRS Form 1099s; (5) subcontractor registration numbers, copies of contracts and invoices; and (6) opt-in forms for corporate officers. Additionally, ESD auditors check that employers have properly reported independent contractors according to the following tests.

Tests by independent contractors of ESD

One of the most common mistakes employers make when filing quarterly unemployment insurance reports is mistakenly classifying workers as independent contractors. If ESD discovers these errors during an exam, the employer must repay taxes for any misclassified workers plus penalties and interest. Accordingly, employers should familiarize themselves with the following tests that ESD uses to determine the status of an employee. Put simply, if an employee passes any of the following tests, they are an independent contractor. If not, the employee is an employee and should be included in the employer’s quarterly unemployment tax report.

Independent contractor test for most industries

First, for all workers except those in the electrical and construction industries, the service provided by a person for remuneration is considered employment (and the worker is considered an employee) unless the employer can demonstrate that:

  1. The person is free from instruction and control over the provision of the service; and
  2. The service is carried out either:
    1. Outside of the usual business dealings for which the service is provided, or
    2. Outside of all registered offices of the company for which the service is provided; and
  3. The person usually works in a self-employed trade, profession, occupation or business that is similar to the type of service contract. (RCW 50.04.140(1))

Or, as a separate alternative, the service provided by a person for remuneration is employment, unless the employer can prove that:

  1. The person is free from instruction and control over the provision of the service; and
  2. The service is carried out either:
    1. Outside of the usual business dealings for which the service is provided, or
    2. Outside of all registered offices of the company for which the service is provided, or
    3. The natural person has a main place of business that is entitled to conduct federal income tax transactions; and
  3. The only one:
    1. usually works in an independently established trade, profession, profession or trade of the same type as the service contract, or
    2. has a main place of business that is entitled to a federal income tax deduction; and
  4. On the effective date of the service contract, the individual is responsible for filing a statement of costs with the Internal Revenue Service (IRS); and
  5. On the entry into force of the contract or within a reasonable period of time after the entry into force of the contract, the person has ascertained that:
    1. An active account with the Ministry of Finance, and
    2. An active account with other government agencies, as required in individual cases, and
    3. A Unified Business Identifier (UBI) number; and
  6. On the effective date of the service contract, the individual will keep separate books or records reflecting all of the income and expenses of the business the individual is running. (RCW 50.04.140(2))

Testing by independent contractors for the electrical and construction industries

Second, ESD uses a slightly different test for workers in the electrical and construction industries that requires contractors to register. For electrical and construction workers in particular, ESD uses the above six-factor alternative test and additionally requires that the person has a valid contractor registration in accordance with RCW 18.27 or an electrician license in accordance with RCW 19.28 if the work requires a Registration or license. (RCW 50.04.145). This means that workers in the electrical or construction industry must be validly registered as contractors in addition to fulfilling the six-factor test above in order to qualify as an independent contractor under the law.

After completing an ESD audit

At the end of an audit, the ESD auditor sends a post-audit letter to the employer in which the results of the audit are explained. If the review results in the employer owing taxes, fines, or interest, ESD sends the employer a Notice and Order for Assessment (NOA) listing any taxes, fines, and / or interest payable due.

If an employer does not agree with the NOA, he can file an objection by writing a letter on the employer’s letterhead requesting an objection and sending it to ESD Tax Appeals or to an Office of Administrative Hearings ( OAH) sends. ESD must receive the letter within 30 days of the date on the NOA. Appeal hearings are typically conducted over the phone by the OAH, and decisions are typically made about two weeks after the hearing is complete. If the determinations of the ESD are reversed, the ESD adjusts the employer’s account according to the determinations of the OAH. If the results of the ESD are confirmed and the employer does not agree, the employer can apply to the Commissioner’s Review Office (CRO) for review. The request for review must be in writing, must be mailed to the Records Center of the Employment Security Department, PO Box 9555, MS-6000, Olympia, WA, 98507-9555, and must be postmarked within 30 days of the OAH dispatch date be provided his decision to the employer. If an employer does not agree with the CRO’s decision, they have 30 days to appeal in writing to the Washington State Superior Court.

Best Practices and Pitfalls to Avoid

  1. Understand the legal standards for independent contractor liability (listed above);
  2. Have independent contractors sign independent contractual agreements that, among other things, expressly deny control and instruction over the worker and do not bind contractors to company guidelines;
  3. Ensure that independent contractors have their own business unit / license, perform independent contractor work for other companies, and do not list the company as an employer on a resume, website or social media platform such as LinkedIn;
  4. Keep records that establish an independent contractor relationship, such as the contract, invoices (describing services that are not part of the company’s business, etc.) for at least three years; and
  5. If employers are contacted by the ESD for an audit, employers should respond promptly to all letters, telephone calls, questions and requests for information; have an employer representative at the audit who is familiar with the work of the employer and the payroll accounting; Providing a private workspace on site or out of the customer’s view to conduct the audit; and ensure that the requested records are well organized and can be easily identified by the auditor.

Finally, employers should consult a trusted legal counsel if they have any questions or concerns about the ESD testing process or whether workers are considered independent contractors or workers.

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