The Huge Mistake Business Owners Make! Hint: Paying Employees in Cash

small business tax tips

A huge mistake that comes up in business is something that doesn’t actually seem like it’s a big deal at all. And that is, paying employees or independent contractors in cash. 

Here’s why. The all powerful Internal Revenue Service, can can disallow the deduction entirely. Meaning if you paid contractors like 50 thousand in cash, because I don’t know, maybe they’re not legal. Can I say that? Maybe the politically correct term is “unauthorized worker”.

Anyway, if you paid contractors in cash, the IRS can argue that you have nothing to evidence your cash payment, therefore you can’t deduct the expense on your taxes. This would effectively increase your taxable income by $50 thousand dollars. That’s about $15 thousand more in taxes you would have to pay the IRS.

So, paying contractors or employees in cash might seem like an easy way to handle things. But it's not a great idea, especially when you think about taxes and the IRS.

For one, when people get paid in cash, there's a bigger chance they won't report it all on their taxes. That means they could skip out on payroll taxes and income taxes, which the IRS really doesn’t like. It also gives an unfair advantage to businesses that don't play by the rules.

Think about it.

Plus, paying in cash makes it very difficult, if not impossible, for the IRS to verify if a payment in the course of business, was really made or not. Meaning, there's no paper trail, so it's way easier for people to lie about how much they made or what they spent.

Also, there’s a tax filing requirement even if you’re paying people using cash. If it’s over $600, an IRS form 1099-NEC is required to be filed with the IRS, with a copy given to the recipient. So they can report the income on their tax return.

Let me tell you a quick story...

So, this guy named Jack owned a landscaping company in the suburbs. Jack couldn’t find qualified workers. So he eventually settled on using “unauthorized workers”. You know, workers without proper work documents like a social security card or even a green card. He reasoned that these were the only workers he could find willing to work.

Okay. He’s paying these workers in cash, under the table. It seems innocent enough right. A win win situation for everyone, right.

Well, it ends up he was audited by the IRS, and guess what?

They disallowed his cash payments to his “unauthorized workers”. He owed the IRS $56 thousand in taxes, penalties and interest. You see, he couldn’t actually prove that he paid the unauthorized workers since he paid them in cash.

Basically, paying in cash, can lead to tax evasion and even fraud. And let's not forget that employees who get paid in cash might miss out on important benefits like social security, unemployment insurance, and worker's compensation.

So, while it might seem like a simple solution at first, paying in cash can lead to a whole bunch of problems with taxes and the IRS. It's definitely something to avoid if you want to keep things on the straight and narrow.

Thanks for reading, and see you in the next blog post!


About The Author

Noel Lorenzana is an Illinois-licensed, Registered Certified Public Accountant with over 20 plus years of experience.

Through his online educational content, YouTube videos, easy-to-understand courses and 1-on-1 consulting, he gives you the tools to become tax savvy for yourself. 

Disclaimer: Any accounting, business or tax advice contained in this article, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.