The story is familiar. A business owner gets into trouble with creditors and tries to save money by not paying payroll taxes. In this case, the owner of a lawn service here in town found herself in cash flow trouble, so she decided to stop paying payroll taxes (federal income tax withholding, Social Security and Medicare withholding). Bad idea. She got into trouble with the IRS, so to make matters worse, she decided to pay her employees in cash so "the government" couldn't take her money. She said her "accountant" told her it was OK to do this. (I want the name of that accountant, to avoid this person!)
I'm not a big fan of all-cash businesses. Receiving money in cash has its advantages, like helping you avoid high credit card fees, but cash businesses have disadvantages, especially when it comes to verifying income for insurance purposes. And what about paying employees in cash? It can get into a whole lot of trouble with federal and state taxing authorities, meaning fines, penalties, and maybe even jail time.
The IRS says,
Paying employees in whole or partially in cash is a common method of evading income and employment taxes. There is nothing wrong with compensating an employee in cash, but employment taxes are owed regardless of how the employees are paid. And the IRS will build its case using all available information even if there are no payroll records or checks.
Think about it this way: While getting paid in cash helps the employee avoid income taxes, it doesn't give that person credits toward Social Security and Medicare. It also doesn't pay unemployment taxes nor does it give the employee the protection of workers compensation in case of an on-the-job injury. So it really cheats the employee.
Some examples of this kind of tactic from IRS investigations in 2011 and 2010, both of which resulted in the business owners receiving jail time and hefty fines and penalties:
- A Wisconsin family "failed to file quarterly payroll tax returns, filed false payroll tax returns, and paid employees in cash to avoid payroll taxes."
- A Florida contractor "used ... cash to pay his workers, which allowed him to report lower wages and lower employment taxes due on [the company's] employment tax returns.
- An Alaska drywall contractor hired undocumented aliens (another federal offense), paid them sub-market wages in cash and failed to withhold and pay employment taxes.
So, if you're thinking about paying your employees in cash, you might want to think again.
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