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California’s Unemployment Insurance (UI) system is the largest such state system in the country, processing 1.5 million new claims per year and paying out more than $5.2 billion annually in UI checks. During the five years (1999-2004) that I was director of the state Employment Development Department, which administers the UI system, I found many California businesses paying too little attention to their UI accounts � to their financial detriment. My colleague, Hilary Hardcastle, and I have compiled the five big mistakes that California businesses make in handling their UI claims, along with providing some advice on how to avoid these mistakes. 1. Failing to timely respond to UI claims When an employer receives a “Notice of Unemployment Insurance Claim Filed” from EDD, it has 10 calendar days from the date the form is mailed to protest the claimant’s eligibility for UI benefits. You’d be surprised at how many employers fail to respond, regarding UI as a government benefits program unrelated to claims made against them. In fact, the employer’s UI tax rate is highly dependent on the number of legitimate claims on its account. Thus an employer who receives such a claim notice should respond promptly in writing to EDD and submit documented facts regarding the events that led to the claimant’s separation. Likewise, a base-period employer who receives a “Notice of Wages Used for Unemployment Insurance Claim” should submit a written statement to EDD within 15 calendar days from the date the notice was filed. EDD may contact the employer to obtain additional information regarding the employee’s separation. Employers should ensure that the person shown as a contact is familiar with the details of the employee’s separation and that he or she is authorized to release the information. A timely written request entitles the former employer to a “Notice of Determination and/or Ruling” informing the employer whether the claimant is eligible for benefits. The employer has a right to appeal EDD’s decision to pay a claimant. It must submit either a completed EDD appeal form or a letter of appeal within 20 calendar days of the date the notice was mailed. 2. Failing to challenge UI rate changes When an employer first registers with EDD, it establishes a reserve account, which is a cumulative record of credits and charges to the account upon which the employer’s annual UI contribution rate is based. An employer’s contribution rate is determined by comparing the employer’s reserve ratio (its reserve account balance over its average base payroll) to the contribution rate schedule in effect for the calendar year. Every December, EDD issues to employers a “Notice of Contribution Rates and Statement of UI Reserve Account” that contains the employer’s assigned contribution rate, annual taxable wage limit, the UI tax rate schedule in effect for the year and the factors used in computing the UI reserve account ratio. An employer may protest any of these items by filing a written statement within 60 days of the date the notice is mailed. In addition to the notice of contribution rates, EDD sends employers a “Statement of Charges to Reserve Account” each October. This statement is an itemized list of benefit charges to the employer’s reserve account for the fiscal year. If the employer wishes to protest a charge, it must do so within 60 days after the date on which the statement is mailed or within an additional period not exceeding 60 days that the director may grant for good cause. While an employer can protest any charge with which it disagrees, it cannot argue that a claimant was ineligible for a benefit payment if the employer failed to file a timely response to the first claim notice or a final decision of an administrative law judge or if the appeals board affirmed the payment of the benefits. 3. Ignoring the distinction between employees and independent contractors An employer is only required to make UI contributions for its former employees, not for independent contractors who performed services for the employer. It is critical that employers note this distinction since misidentifying an independent contractor as an employee affects not only an employer’s tax base but also its reserve account to the extent benefits claims are made by misidentified independent contractors. Likewise, misclassification of employees as independent contractors can lead to costly audit assessments for unreported wages. The distinction between employees and independent contractors is by no means a clear one (EDD has made several attempts in recent years to set more definite guidelines by industry sector). Existing EDD guidelines and case law set out the factors that should be considered by the department in evaluating a classification (i.e., whether the hirer instructs or supervises the person while he or she is working, whether the hirer has the right to discharge the worker at will and without cause, whether the worker has his own tools or his own separate business). However, in most contested cases, the department weighs a number of factors in determining whether the employer exercises sufficient control. We’ve seen numerous employers who believe they can ensure a determination of independent contractor status by a written agreement with the worker stating this arrangement. Even if a written contract claims to create an independent contractor/principal relationship, it is not determinative. When an employer is uncertain as to a worker’s status, it can ask EDD for a written determination based on the facts presented. Alternately, the employer can work with counsel in structuring the work relationship to ensure either the desired independent contractor or employee status. 4. Failing to protect against identity fraud UI identity fraud is a rapidly growing crime, in line with the growth of identity fraud in other areas of finance and government benefits. Identity fraud also can drive up an employer’s UI costs. Identity fraud occurs when someone files a UI claim using another person’s employment information. Employers can protect against UI identity fraud in several ways. First, they should ensure that they properly dispose of old payroll records, thereby protecting their employees’ personal information. If an employer believes that its payroll or personnel data has been compromised or if it suspects fraudulent activity on its account, it should promptly inform EDD. Second, employers should carefully review UI claim notices received from EDD to determine if there are any discrepancies and report any that they discover. They should watch out for names and Social Security numbers of individuals who are still employed by them, never worked for them or who they believe are not entitled to benefits. 5. Turning to third-party contractors who promise lower UI rates California employers may hear from third-party firms promising lower UI rates by transferring employees from one business entity to another. Beware. There are legitimate ways for employers to minimize UI rates, but a number of the approaches put forward in recent years are in violation of the State Unemployment Tax Act dumping guidelines enacted in 2005 by the state Legislature in AB664. Illegal approaches can include the “purchased shell transaction” in which a business purchases a corporate shell with a low UI rate and transfers payroll to the purchased entity; the “affiliated shell transaction” in which a new corporation is registered and a small payroll reported each year until a low or minimum UI rate is achieved; and the “new employer rate” by which an employer with a high UI rate files for a new employer account. EDD has taken a very aggressive position in recent years against these approaches and others and has targeted unemployment tax dumping as one of its enforcement priorities. The California employer who takes the time to understand and pay attention to its UI rights and responsibilities can avoid significant financial costs � and a lot of aggravation. Michael Bernick and Hilary Hardcastle are attorneys in the San Francisco office of Sedgwick, Detert, Moran & Arnold.

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