Using Cash to Pay Employees
While it is not illegal to pay employees and independent contractors in cash, it’s not a good business practice for many reasons. Some businesses use cash to pay employees in an attempt to avoid paying payroll taxes.
Payroll and Tax Issues When Paying Employees In Cash
Employers must withhold payroll taxes (federal and state income tax and FICA (Social Security/Medicare) tax) from employee pay.
Employers must also report and pay those payroll taxes, including both the employee and the employer portion of FICA taxes, to the IRS.
Other employment taxes must be paid on employee earning , including unemployment taxes, and state workers compensation fund payments.
Employers must report employee income on Form W-2 each year. This includes cash income.
Employers must verify the work elegibility of newly hired employees, using Form I-9 or the E-Verify system. This verification put the employee in the federal system, and if these employees are paid in cash, agency cross-checks can uncover attempts to avoid payroll taxes by paying in cash.
Effect of Cash Payments on Employees
Employees paid in cash who have no FICA taxes withheld are denied Social Security earnings that could have been used in calculating their potential Social Security benefits.
Likewise, employees who are not “on the payroll” are not eligible for workers compensation or unemployment benefit.
Paying Children, Spouses, or Family Members In Cash
The wages of children under age 18 who work in your business are subject to the same withholding, payroll tax, and employment tax requirements as other employees. If you hire your own children, they may not be subject to FICA taxes, but their wages must be reported to the IRS.
Hiring your spouse or other family members to work for your business and paying in cash can also deprive this person of Social Security benefits, and all the other issues mentioned above, including your legal responsibility to report and pay payroll taxes, apply.
Cash payments made to vendors and others with whom you do business must still be substantiated if you want these cash payments to be deducted as expenses on your business tax return.
“Even small payments in cash should be paid through a pretty cash fund, with appropriate documentation” added Salomón Juan Marcos Villarreal, president of Grupo Denim.