EDD Payroll Verification Test: What Is the Auditor Checking?

By Marc Boulanger, CPA

During a California EDD employment tax audit, the auditor does not simply accept the payroll reports provided by the business. The auditor may compare the employer's payroll records with tax returns, wage reports, accounting records, and other documents to determine whether wages were completely and accurately reported.

From an accounting perspective, this is essentially a reconciliation exercise: Do the different records tell the same story?

Why Does EDD Verify Payroll?

Payroll records originate in one system but eventually appear in several different places.

An employee's compensation may appear in:

• The payroll journal
• The employee's individual earnings record
• Quarterly California wage reporting
• California employment tax returns
• Federal payroll tax returns
• Form W-2
• The company's general ledger
• The company's financial statements

If those records do not reconcile, the auditor may need to determine why.

What Payroll Records May EDD Review?

EDD's published employment tax audit guidance identifies several records used for payroll verification, including:

• Payroll journals
• Individual employee earnings records
• Payroll summaries
• Forms W-2
• Forms W-4
• Forms 941
• Form 940
• Forms DE 9
• Forms DE 9C
• Forms DE 9ADJ
• Forms DE 678
• Forms DE 4

The auditor may also examine the general ledger, bank records, financial statements, tax returns, Forms 1099, and other accounting records as part of the broader employment tax audit.

See our detailed guide: What Records Does an EDD Auditor Request?

What Is the Auditor Trying to Reconcile?

The exact procedures depend on the employer and the audit. But conceptually, the auditor is looking for consistency between the underlying payroll records and what was reported to taxing agencies.

The CPA Question: Do the Numbers Tie?

This is where an accounting-based review can be particularly useful.

Before the auditor performs the comparison, I want to know whether the employer's payroll records reconcile.

For example:

• Do quarterly payroll reports reconcile to the annual payroll totals?
• Do the Forms W-2 reconcile to the payroll system?
• Do the California filings reconcile to the underlying payroll records?
• Do federal payroll filings make sense in relation to the same payroll?
• Does payroll expense in the general ledger reconcile to the payroll records after accounting for legitimate differences?
• Are there payments to individuals elsewhere in the general ledger that were not processed through payroll?

What if the Payroll Records Do Not Match?

A difference does not automatically mean wages were underreported.

Accounting and payroll records can differ for legitimate reasons.

The important question is whether the difference can be identified, reconciled, and supported.

Potential explanations can include timing differences, payroll corrections, voided checks, adjustments, entity changes, bookkeeping classifications, or differences between gross payroll and the amounts recorded in particular expense accounts.

The specific explanation should come from the employer's actual records rather than from assumptions.

Why the General Ledger Matters

The payroll journal tells the auditor who the business acknowledges as employees.

The general ledger can tell a much broader story about who was paid for services.

Payments may appear in accounts such as:

• Contract labor
• Outside services
• Commissions
• Professional fees
• Repairs and maintenance
• Management fees
• Officer or shareholder payments
• Reimbursements
• Miscellaneous expenses

Not every payment in these accounts represents wages. But payments to individuals outside payroll can lead to additional questions.

What About 1099 Workers?

Payroll verification and worker classification can overlap.

An employer may have perfectly accurate payroll records for everyone it treated as an employee while still facing an audit adjustment because EDD concludes that certain individuals paid outside payroll should also have been employees.

That is why I do not review the payroll system in isolation. I also want to understand payments made to individuals outside payroll.

See: EDD Independent Contractor Audit Guide

Payroll Verification Is Different From the ABC Test

These issues are related, but they should not be confused.

Payroll verification asks whether acknowledged employee wages and related payroll reporting are complete and accurate.

Worker classification asks whether individuals treated as nonemployees should have been treated as employees under the applicable California classification standard.

For workers subject to the ABC test, see: California ABC Test in an EDD Audit: A, B and C Explained

What Is the EDD Audit Test Year?

EDD states that an employment tax audit generally covers a three-year statutory period consisting of the 12 most recently completed calendar quarters.

The examination generally begins with a test year, normally the most recently completed calendar year.

The auditor can use that period to examine the employer's payroll reporting and other employment tax issues. Depending on what the examination identifies, the audit may expand through the applicable audit period and, in some circumstances, beyond it.

See: How Long Does an EDD Audit Last?

What I Review Before EDD Tests the Payroll

Before providing payroll records to an EDD auditor, I want to understand whether the records reconcile and where questions are likely to arise.

Depending on the business, I may look at:

• Payroll journals by quarter
• Employee earnings records
• Forms W-2
• DE 9 and DE 9C filings
• Forms 941 and 940
• General ledger payroll accounts
• Contract labor and outside-service accounts
• Forms 1099
• Bank and check records when relevant
• Payroll adjustments and amended filings
• Changes in payroll providers
• Changes in business entities or ownership

If there is a difference, I would rather identify it and understand it before the auditor asks about it.

Multiple Entities and Payroll Changes

Reconciliations can become more complicated when a business changed entities, changed ownership, switched payroll providers, or moved employees between related companies during the audit period.

The records may be accurate individually but difficult to understand when viewed without the history of the business.

Those situations should be organized before the records are presented so the auditor can understand which entity reported which employees and during which periods.

What About Cash Payments or Payments Outside Payroll?

Payments made outside the normal payroll system deserve careful review.

The fact that a payment was made by check, cash, electronic transfer, or through an accounts-payable system does not by itself determine whether it represents wages.

The auditor may need to understand who received the payment, why it was made, what services were performed, and whether the recipient was properly classified.

Common Problems I Would Look for Before an EDD Payroll Review

• W-2 totals that do not reconcile to payroll reports
• Quarterly filings that do not reconcile to annual payroll totals
• Payroll expense that cannot be reconciled to the payroll system
• Workers appearing both in payroll and contractor records without a clear explanation
• Large payments to individuals outside payroll
• Missing payroll periods or reports
• Payroll provider changes with incomplete historical records
• Amended returns that are not reflected consistently across the records
• Multiple entities with payroll activity that has not been separated clearly

EDD Payroll Verification FAQs

What is the EDD payroll verification test?

It is part of the employment tax audit process used to verify that acknowledged gross wages and taxable wages were properly reported and that payroll-related reporting is consistent with the employer's underlying records.

What records does EDD use to verify payroll?

EDD may review payroll journals, employee earnings records, payroll summaries, Forms W-2, Forms 941 and 940, California DE 9 and DE 9C filings, and other payroll and accounting records.

Does EDD compare payroll to the general ledger?

The general ledger is among the records EDD identifies for an employment tax audit. It can help the auditor understand payroll expense and identify other payments made for services.

What happens if my payroll records do not match?

A difference does not automatically establish underreported wages. The cause of the difference should be identified and supported by the employer's records.

Does payroll verification include 1099 contractors?

Worker classification is a related audit issue. EDD may review payments to individuals outside payroll and determine whether people treated as independent contractors were properly classified.

What is the EDD audit test year?

EDD states that the audit generally begins with a test year, normally the most recently completed calendar year, before the examination is expanded as appropriate within the audit period.