For many, paying employees cash seems like the easiest way to handle things. However, while it may seem easier, in the long run if you get caught by the IRS, it’s going to be difficult to deal with.

Although it is not illegal to pay employees and contractors in cash, there are a variety of downfalls associated with this business practice. Most importantly, it complicates the process of paying an accurate amount of payroll taxes.

If you decide to pay employees cash, you should first discuss this idea with your accountant. A tax professional can provide you with advice on what you should and should not be doing, including how to avoid serious trouble with the IRS (businesses paid $4.5 billion in payroll tax penalties last year).

Here are several key details to consider:

• You are required to report all wages to the IRS, including those that are paid in cash. If you pay a worker in cash, you are still required to pay payroll taxes. Not doing so means you are paying the person “under the table,” which is illegal. If you neglect to do so and your business is audited, you could find yourself facing a large penalty.

• Accurate records are a must. If you decide to pay an employee in cash, keep accurate records of how much you paid them as well as the date on which the money was surrendered. Again, this can help protect against future issues, such as in the case of an audit.

• Impact on workers’ compensation and unemployment. What happens if you pay in cash and a worker files a workers’ compensation claim? What happens if the person attempts to claim unemployment benefits? If you don’t keep accurate records, any claim could lead to an audit. Not to mention the fact that you may also be in direct violation of unemployment and workers’ compensation laws. Remember, you are required to pay unemployment tax and workers’ compensation insurance.

Potential Pitfalls of Paying Employees in Cash

By now, you realize that it’s legal to pay employees in cash. However, you also realize that this can bring forth a variety of potential pitfalls, including but not limited to:

• Safety risk: It’s unsafe to withdrawal a large amount of cash and keep it in your possession until you pay your employee or contractor. Also, if something does happen to the money, you don’t have any recourse.

• Easier to make payroll mistakes: Just because you’re paying someone in cash doesn’t mean you can bypass all payroll and tax related laws. This increases the likelihood of making a mistake, often as a result of poor record-keeping.

• Potential for serious penalties: Even if you make an honest mistake, you can face consequences ranging from fines to imprisonment (in the most serious of cases).

• It harms your employee: Some people believe it’s okay to pay cash under the table as long as their employee agrees to the arrangement. Even if you get away with it, your employee is missing out on benefits, such as the ability to earn Social Security credits.

• Your employee could turn you in: When paying under the table, you assume that you and your employee are on the same page. However, if something happens, such as you terminating their employment, they could turn you into the appropriate tax agency.

Again, while it may not be illegal to pay employees cash, you are definitely taking a risk when doing so. The best way to protect against this is to pay each employee via check or direct deposit, which can be done easily using a payroll service.

Having a payroll service also automatically gives you payroll reports and pays and files payroll taxes. It’s a great way to bypass some of the complications that come with paying employees.

Having a payroll service also automatically gives you payroll reports and pays and files payroll taxes. It’s a great way to bypass some of the complications that come with paying employees.