UC Tax Audit Documentation Requirements

U.S. Department of Labor
Employment and Training Administration
Washington, D.C. 20210
Classification: UI
Correspondence symbol: TEUMI
Issue date: March 18, 1992 [as printed in OUI HTML; ETA’s 1994 checklist gives March 18, 1993]
Rescissions: None
Expiration date: March 31, 1994
Directive: UNEMPLOYMENT INSURANCE PROGRAM LETTER NO. 18-93
To: ALL STATE EMPLOYMENT SECURITY AGENCIES
From: BARBARA ANN FARMER, Administrator for Regional Management
Subject: UC Tax Audit Documentation Requirements

1. Purpose. To provide State unemployment insurance (UI) program administrators with revised documentation standards for unemployment compensation (UC) tax audits.

2. Reference. Employment Security Manual (ESM), Part V, Section 3670-3693; Field Audit Function (ETA Audit Policy); Core Revenue Quality Control, Operations Handbook; and Unemployment Insurance Program Letter No. 48-92.

3. Background. The Employment and Training Admnistration (ETA), in response to unfavorable reports by Federal and State audit agencies, has taken certain actions to improve the quality of State UC field tax audits. To this end, the ETA has developed procedural changes in its oversight functions to ensure that field audits are of consistent and acceptable quality. A number of tests included in the Revenue Quality Control (RQC) program will be used to evaluate the adequacy of documentation to support auditors' actions, findings, recommendations and other pertinent information in performing employer audits. The audit documentation criteria were developed in a workshop of State and Federal UC tax specialists.

   Compliance with the taxation and coverage provisions of complex State UC laws, complicated by their inter-relationship with Federal employment tax laws, is subject to a broad range of interpretation. Inadequate audit performance supported by little or no reliable documentation has been cited by outside authorities such as the Inspector General as a major deficiency in State UC tax operations. Lacking specific guidance or a definition of "documentation," the States have supplied their own interpretation of what documentation means, often based on expediency, with disparate and generally inadequate results. Although ETA Audit Policy has stated that documentation should support auditor findings, there has been no definitive discussion of what constitutes documentation.

   RQC studies have confirmed that very few State audit programs could meet even rudimentary quality requirements because of a general lack of reliable documentation. In an eight-State pilot test, RQC found that only two of the eight participating States have audit programs with adequate documentation.

   The reliability of State UC audit performance can be improved by expanding the ETA Audit Policy to prescribe documentation requirements and to include documentation criteria in the RQC requirements. A work group of State and Federal UC tax experts, using the results of the eight-State review as a basis, proposed criteria establishing minimum levels of acceptable field audit documentation. The work group divided their recommendations into five categories, and further, concluded that to be applied uniformly by the States, the documentation requirements must be standardized.

4. UC Tax Audit Documentation Requirements. As set forth in UIPL No. 48-92, modifications to the UC Field Audit Policy and RQC documentation criteria were proposed and submitted to the States for their consideration and comment. Major State concerns centered on increased workload, reduction of the four percent audit penetration desired level of achievement (DLA), and the amount of detail required in pre-audit and post-audit documentation.

   The bases for field audit documentation criteria, taking into consideration State comments and recommendations, have been incorporated into the Employment Security Manual (ESM), ETA Audit Policy, a copy of which is attached.

   The Field Audit Acceptance Sample instructions in the draft RQC Operations Handbook have been revised to address State concerns about the stricter documentation standards. The revised instructions, which will be provided to State Quality Control staff under a separate directive, address issues such as employers who do not maintain full accounting systems.

5. Desired Level of Achievement. Although States anticipate few problems implementing higher documentation standards, it is recognized that increasing the amount of documentation required will increase the time needed to complete an audit. Several States have indicated they will be unable to meet both the heightened documentation standards and the current four percent DLA for audit penetration. Therefore, it is agreed that the current DLA will be adjusted to accommodate the new documentation criteria.

   The four percent audit penetration DLA is replaced with a two percent minimum DLA for FY 1993. However, States deeming a more aggressive audit program to be advisable are encouraged to raise their standards accordingly. The DLA shall remain at the two percent minimum until a DLA can be established under the Performance Measurement Review project.

6. Action Required. State Administrators are requested to review the attached documents and to provide the information and instructions to appropriate UI staff.

7. Inquiries. Direct inquiries regarding this directive to the appropriate ETA Regional Office.

8. Attachment. MTL 1469

Attachment — Employment Security Manual, MTL 1469
Official attachment: https://oui.doleta.gov/dmstree/uipl/uipl93/uipl_1893a.pdf

UIPL 18-93 Attachment

                                EMPLOYMENT SECURITY MANUAL       MTL 1469


Part V                  Unemployment Insurance Program   Contents (4)
3000-3999                    Contributions                R- 3/93


FIELD SERVICE........................................ 3600-3699

      Field Audit Function............................ 3670-3693

             Objectives of Field Audit Program..............    3670
             Definition of a Field Audit....................    3671
             Definition of a Change Audit ..................    3673
             Scope of Audits................................    3675
             Subject Employer Audit Penetration ............    3677
             Selection of Employers for Audit ..............    3679
             Field Audit Manual ............................    3683
             Contents of an Audit ..........................    3687
             Control of Field Audit Assignments ............    3689
             Review of Audits ..............................    3691
             Field Audit Program Evaluation ................    3693

EXPERIENCE RATING.................................... 3700-3799

      Transfers of Experience

             Total Transfer of Experience ..................    3700
             Partial Transfer of Experience ................    3772
             Rate Allowed Transferring Employer for
              Remainder of Rate Period After Transfer ......    3774
             Fulfillment of the 3-year Requirement..........    3776

      Noncharging of Benefits ........................ 3780-3789

             Omission of Charges to Employers' Accounts .... 3780

      Joint Accounts

             Rates Allowed a Group of Persons (Joint Accounts)
             After the Withdrawal of a Member (or Members) From the Group
             3790


                            EMPLOYMENT SECURITY MANUAL             MTL 1469
Part V                    Unemployment Insurance Program           3670-3671
3670 - 3693                     Contributions                 R-3/93

                                      THE FIELD AUDIT FUNCTION

3670   Objectives of a Field Audit Program. A comprehensive field audit program is vital to the administration
       of a State unemployment compensation system. A well-planned and cost effective field audit program,
       executed in coordination with central office activities and other unemployment insurance field
       undertakings, is an efficient means of ensuring compliance with State Unemployment Compensation law
       and timely collection of taxes on an equitable basis.

3671   Definitions.

       Field Audit. A field audit, as the term is used herein, is a systematic examination of a subject employer's
       books and records, using generally accepted auditing standards and procedures, covering a specified
       period of time during which the employer is liable for reporting under the law. An effective audit will
       accomplish the following:

       A.     Determine the taxable amounts of payments made by an employer for personal services and the
              contributions paid or payable on such amounts;

       B.     Reconcile audit findings with amounts the employer has reported to the State agency, if any;

       C.     Determine interest and/or penalties due under the State employment security law;

       D.     Determine, if necessary, the employer's financial liability to meet UC tax obligations; and

       E.     Provide a cost effective method of promoting employers understanding of employer rights and
              responsibilities under State unemployment law.

       In addition, an audit as defined must meet the following minimum requirements:

              1.      An opening interview,

              2.      Cover a minimum four calendar quarters (except as noted in 3675 A),

              3.      Verify the business entity as a sole proprietor, partnership, corporation, Joint venture, or
                      other,

              4.      Document records examined and evidence obtained in tests used to verify payroll
                      procedure, accuracy, and completeness,

              5.      Document records available and examined and the evidence obtained in the search for
                      misclassified workers and payments,

              6.      Conclude with a closeout conference with the employer or a designated representative. If
                      closeout not possible, explain in report,

              7.      Include a written report stating the auditor's final determination and all facts contributing
                      to or supporting that determination.

       Change Audit. An audit resulting in the discovery of wages or taxes not previously reported or reported
       incorrectly by the employer.

       Conclusion. An expression in the audit report of the auditor's opinion regarding the employer's
       compliance with State UI laws.

       Employer/Designated Representative. The owner, general partner, corporation officer, any employee
       or other individual with written authorization to access and make available all employment records.

       Evidence. The data and information an auditor obtains during an audit that has a bearing on findings
       and supports conclusions and determinations.

       Findings. A logical pulling together of information to arrive at conclusions about matters which were
       analyzed or evaluated (e.g., a response to a test of transactions). Findings will be the basis for the
       auditor's conclusion(s).

       Reconciliation. Comparing two or more items and identifying and resolving any differences.

       Source Document. A record of initial activity or transaction. Examples of source documents include
       time cards, canceled checks/stubs, cash vouchers, purchase/sales records.

       Test of Transaction. A procedure used by an auditor to test the reliability of internal processes and/or
       evidence supporting findings and conclusions affecting employer compliance with State UC laws,
       regulations and policy. Included are tests to authenticate payroll systems from source documents to
       accounting records, and through to employer contribution reports.

       Tolerance. A schedule of monetary deviation from a standard established by the State for auditor
       guidance in determining the need and scope of an extension. Tolerance definitions may be based on a
       percentage of taxable payroll or contributions. Variances may be allowed for size of payroll and/or tax
       rate.

       Work Paper. Any document prepared or obtained by the auditor in the performance of an audit.
       Included in work papers are analyses, transcriptions, letters, memos, and confirmation results related to
       compliance with UI laws. Work papers serve as the basis of the work performed, and support the
       auditor's conclusion. Upon review of work paper(s), a reviewer can determine the quality of work
       performed.

3675   Scope of Audits. The scope of an audit is the number of quarters examined.

       A.     Audit period. An audit must cover a minimum of four (4) consecutive quarters for which
              reports have been submitted by the employer, except registered (active) or out of business
              (inactive) employers who at the time of the audit have operated less than four quarters. It is
              acceptable to audit quarters for which estimates, assessments, final assessments or jeopardy
              assessments have been made.

              It is not necessary for each audit to cover the entire period of liability, the entire period since the

              last audit, or the statute of limitations.

       B.     Extending the Audit. If a sample of quarters audited produces amounts over the tolerances
              established by the State, the audit scope should be extended as necessary to account for all
              payments for personal services. If the auditor elects to disregard the tolerance, the decision
              should be explained in the audit report. In any case, the audit should not be extended beyond the
              statute of limitations, or the period covered by a prior audit unless State law provides otherwise.

       C.     Finality. If a money deficiency is established during an audit, the auditor should initiate
              collection procedures. Collection at time of audit is desirable.

3677   Subject Employer Audit Penetration. The number of audits to be conducted each fiscal year (FY)
       represents a percentage of subject contributory employers at the end of the immediately preceding fiscal
       year. Example:

              The audit count for FY 1993 will be based on the number of contributory subject employers as of
              September 30, 1992.

       Refer to the "desired level of achievement" (DLA) in the UI Quality Appraisal System for the percentage
       (penetration rate) of employers to be audited during a fiscal year. Exclude reimbursable and
       governmental entities from the universe of employers to be audited.

3679   Selection of Employers for Audit. States are encouraged to maintain audit selection criteria that
       include indices that reflect potential noncompliance such as high employee turnover, sudden growth or
       decrease in employment, type of industry, location (geography) of employers, prior reporting history,
       results of prior audit and adjudicated determinations.

       To ensure that all employers are included in the audit selection process, at least 10% of audit
       assignments must be randomly ~elected from the total universe of contributory employers.

       To assure inclusion of large employers in the audit program, 1% of total audits required to meet the audit
       DLA must be large employers. All States must include at least one large employer in their annual audit
       program. Large employer is defined as an employing unit reporting wages paid to l00 or more
       individuals during the current or preceding calendar year or an employing unit reporting at least one
       million dollars ($1,000,000) in taxable payroll for the calendar year preceding the first guarter being
       audited. Either term of definition may be used in ~electing large employers as long as each large
       employer audit can be identified and verified by number of employees or size of payroll.

       Assignments issued to resolve report and money delinquency, blocked claims, and status assignments
       should not be routinely converted or expanded to audits. If circumstances indicate problems or
       conditions not apparent when the assignment was made, then expansion of the assignment to include an
       audit may be warranted.

       Field collections incident to delinquent employer contacts or collections made at the time of initial
       employer registration (status assignments) in the field are not audit performance measurements. Such
       collections are not to be counted as audit yield.

3683   Field Audit Manual. To effectively administer its field audit program, each State must maintain a

       current Manual of Field Audit Procedures. The manual should cover the following procedures:

       A.     Assignment preparation,
       B.     Setting up audit appointments,
       C.     Pre-audit discussion with employer or a designated representative,
       D.     Steps in conducting the audit,
       E.     Closeout discussion with employer or an employer's authorized representative, and
       F.     Instructions for preparing the field audit report.

3687   Contents of an Audit Report. A completed change and no-change audit will be documented by a
       written record which contains work papers presenting evidence and supporting findings and conclusions.
       The audit findings will be explained and be in accordance with the specific requirements of State law,
       administrative rules and procedures. All audit reports should contain sufficient information to show:

       A.     Name and title of the individual with whom the purpose of the audit we. discussed prior to the
              audit. When an employer designates a representative' the name and title of the authorizing
              employer and the designated representative must be recorded;

       B.     How existence of the business was verified;

       C.     How ownership was verified;

       D.     What payroll record tests were performed and what evidence was gathered to verify the accuracy
              and completeness of payroll, including, but not limited to:

              1.      Verification of payroll posting system,
              2.      Reconciliation of total payroll to total wages,
              3.      Computation of total taxable payroll,
              4.      Reconciliation of verified total taxable payroll to reported total taxable wages;

       E.     What other employer records were available and examined and what evidence was gathered to
              search for misclassified workers and hidden wages, including, but not limited to:

              1.      Contract labor records,
              2.      Cash disbursements,
              3.      General ledger/chart of accounts,
              4.      Miscellaneous account reports and records;

       F.     What reason was given for the number of quarters audited (if more or less than four quarters);

       G.     Name, title, and telephone number of the individual with whom a closeout meeting was held;

       H.     That all monies due were collected and, if not, an explanation provided;

       I.     That necessary adjustment forms were completed with the audit.

3689   Control of Field Audit Assignments. The central or district office should maintain a numeric control
       file of field audit assignments. The control file should be automated to the extent possible, show the date

       issued, the tax office or individual to whom assigned and the date completed. The control file should be
       monitored to insure audit assignments are completed timely.

       If an auditor conducting a status assignment, delinquency control, benefit wage verification or other
       non-audit assignment, determines an audit is essential to resolve an issue or to complete an investigation,
       the four quarter minimum scope requirement should be complied with. Justification for the decision to
       audit must be included in both the audit report and report of the assignment.

       Selection of audit assignments should:

       A.     Generally, not be left to the discretion of the individual auditor;

       B.     Be made from either the district tax office or central office;

       C.     Be automated and capable of selecting accounts for audit on a periodic basis, assigning to local
              offices, monitoring audit results for determining audit yield and interfacing with
              employer/employee files to assure current and accurate management information.

3691   Review of Audits. Review all completed field audits to assure credibility of results and efficiency of the
       audit completion. A properly executed review will answer the following questions:

       A.     Was the purpose of the audit discussed with the employer or a designated representative prior to
              the audit? (If a designated representative, the name and title of the authorizing employer and the
              designated representative must be recorded.)

       B.     Was existence of the business verified?

       C.     Was ownership verified?

       D.     Were tests of payroll records performed and was evidence gathered to verify the accuracy and
              completeness of payroll, including, but not limited to:

              1.      Verification of payroll posting system,
              2.      Reconciliation of total payroll to total wages,
              3.      Computation of total taxable payroll,
              4.      Reconciliation of verified taxable to reported total taxable wages?

       E.     Were all available employer records identified and examined and was evidence gathered to
              search for misclassified workers and hidden wages, including, but not limited to:

              1.      Contract labor,
              2.      Cash disbursements,
              3.      General ledger/chart of accounts,
              4.      Miscellaneous account reports and records?

       F.     Was a reason given for the number of quarters audited?

       G.     Was the closeout meeting held with the employer or a designated representative? (When the

              employer designates a representative the name and title of the employer and the designated
              representative's name, title and telephone number must be recorded.)

       H.     Were necessary adjustment forms completed with the audit?

       I.     Were all monies due collected and if not, was an explanation provided?

       In addition, at the Tax Administrator's direction, a statewide sampling of completed audits should be
       reviewed periodically at the central office level to ensure uniform quality of field procedures and staff
       performance throughout the State.

       Additional revenue generated by field audits should be routinely evaluated to determine effectiveness of
       the audit program.

       Periodic evaluation of the State's audit program is essential to identify weaknesses and problems. Quality
       work is materially affected by agency policy and procedures which produce the audit. Defects in policy
       and procedures may be a cause of poor auditor performance and as such need to be identified and
       corrective action taken. For instance, analysis of audit results may indicate some audit assignments
       should properly have been wage protest investigations or delinquency assignments rather than audits.

3693   Field Audit Program Evaluation. A management information system should be designed to provide
       management with information to monitor and evaluate the field audit program.

       A.     Data Collection. The data collection from completed audits should include:

              1.      Number of audits completed;
              2.      Number of large employers audited, according to State's definition of large employer;
              3.      Number of audits which were change audits;
              4.      Number of calendar quarters audited;
              5.      Hours spent (excluding travel) auditing;
              6.      Gross payroll audited;
              7.      Under-reported total wages found;
              8.      Under-reported taxable wages found;
              9.      Over-reported total wages found;
              10.     Over-reported taxable wages found;
              11.     Under-reported contributions; and
              12.     Over-reported contributions.

       B.     Data Analysis. The data sbould be analyzed by computer operations, if possible, to produce the
              following:

              1.      Percentage of change audits;
              2.      Percentage of large employers audited to the total audits;
              3.      Average number of quarters audited per audit;
              4.      Average time (hours) per audit (exclusive of travel);
              5.      Average amount of gross payroll audited;
              6.      Average amount of under-reported total wages discovered per audit;
              7.      Average amount of over-reported total wages discovered per audit;

       8.      Average total wages discovered (under-reported plus over- reported) per audit;
       9.      Average amount of under-reported contributions per audit; -
       10.     Average amount of over-reported contributions per audit;
       11.     Average amount of contributions discrepancy (under-reported plus over-reported per
               audit).

C.     Data Uses. Criteria developed from the data elements can form the base from which
       management can evaluate individual or overall performance against pre-determined achievement
       standards. Effective analysis of audit results assures the most productive utilization of field tax
       resources. Measurement selection should include change ratio, additional wages discovered,
       taxes discovered, additional workers discovered, employers by size, industry code, location.

Analysis of the audit program results should be a prominent factor in the selection of employers for
audit.