It is not a good business practice to pay cash for wages.
Issues when paying employees cash
1. You are exposed to income tax audits of both agencies federal and state for not reporting the wages.
2. You have the legal obligation to withhold payroll taxes and report wages.
3. There are no check stubs, no payroll and income tax withholdings, no issuance of Form W-2, or records to substantiate earnings.
4. It is illegal to pay cash wages “under the table to evade payroll taxes” and could be subject to criminal prosecution.
5. Benefits like state disability insurance could be denied when filed.
6. If your employees are injured on the job, they have the right to file a claim for Worker’s Compensation or State Disability Insurance benefits. If your employees’ wages have not been reported, an examination by EDD will follow.
7. The injured employee may also collaborate with personal injury lawyers.
Why do businesses pay cash wages “under the table”?
1. To avoid payroll taxes, income tax withholdings, and insurance expenses associated with payroll.
2. An accommodation of an employees’ request who want to receive all of their gross earnings.
3. To avoid bookkeeping burden and cost associated in maintaining the books.
4. To gain an unfair competitive advantage.
5. To go with the trend of industry practice.
Underground economy operation (UEO)
IRS, EDD, and DOL formed a Joint Enforcement Strike Force (JESF) to fight the Underground Economy for unfair competitive advantage. If audited, an employer may have to pay penalty, interest, and audit defense costs. This liability could grow substantially if the data is shared with IRS for federal payroll taxes and DOL for overtime and workers’ compensation insurance. Dealings in cash could also be referred to the IRS Criminal Investigation Division for aiding and abetting employees to avoid paying taxes.
Unreported wages
If EDD finds unreported wages, you will be required to reconstruct payroll for many years, a time-consuming task. If fraud or intent to evade the law is found, there is no statute of limitations to protect you and the audit could go back to the start date of your business. It could end up costing far more for reconstructing records from time cards, cancelled checks, and other records that may have already been discarded, than if you had correctly reported wages from the beginning. Your business may not be able to survive for this costly audit.
Disclaimer: Any accounting, business or tax advice contained in this communication is neither 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.
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Al-os & Associates Accountancy Corporation provides accounting and tax services to individuals, corporations, LLCs and business entities. The Firm has a niche in defending taxpayers audited by the IRS and other governmental agencies.
