The Payroll Blog

News, tips, and advice for small business owners

Paying Employees Cash and How to Do It Legally

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Chris Bibey

If you’re starting a new business or trying to support your employees during a difficult time and you’re wondering how to pay employees in the most efficient way possible, your mind may immediately jump to cash.

Cash sitting in an animal trap.

While cash may be king, it’s not the ideal method for payroll. Even though it may be the easiest and fastest way to distribute payment to employees, payroll errors can lead to penalties with a variety of enforcement agencies including the IRS and DOL.

Is It Illegal to Pay Employees Cash?

It is not illegal to pay individuals in cash, however, there are several downfalls generally associated with this business practice. It may complicate the process of paying the accurate amount of payroll taxes. The term “under the table” is used when employers pay employees cash and do not deduct the necessary payroll taxes. Cash wages need to be treated like any other wages, which is why if you aren’t withholding payroll taxes, you could land in hot water with the IRS.

Potential Pitfalls of Paying Employees in Cash

Every small business operates differently. Therefore, if you want to use cash to pay employees, you can, but there are some considerations you’ll want to keep in mind.

  • Safety risk. Depending on how many employees you have, you may find yourself making large withdrawals. It can be unsafe to carry large amounts of money for an extended period due to the risk of theft, or even just falling out of your pocket without noticing.
  • Wage statements. Wage statements are required in many jurisdictions regardless of the method of payment. Although these can be provided if an employer pays in case, they are often forgotten. Penalties for not providing are generally per employee and per pay period which can lead to large penalties.
  • Proof of payment. Payment on payday is also required in many jurisdictions. Checks help show payroll was provided on payday that as they have a date. Employers who pay cash may wish to get signed receipts from employees that they received the payment.
  • Easier to make payroll mistakes. Opting for DIY payroll can be easy, but there can be some added complexity if you’re using cash. Important payroll taxes can easily be miscalculated, or not paid at all, and it’s harder to fix mistakes when you’re using paper money.
  • Potential for penalties. Building on the last point, ongoing payroll mistakes can be a red flag to enforcement agencies. Even if you make an honest mistake, you can face the consequences ranging from fines to audits to imprisonment in the most extreme cases.
  • Negative consequences for employees. While in the short term your employee may be thrilled to receive cash, over time it can negatively impact them due to the lack of an official paper trail.
  • Lack of funding options. When you don’t have a formal payroll set up, it can be challenging to get loans and other funding when you find yourself in a pinch.

How to Pay Employees Cash Correctly

Now that you’re aware of the pitfalls of cash wages, if you still want to proceed, there are some ways to help ensure you are remaining compliant.

  • Understand payroll tax requirements. Payroll can be a daunting task because of the different tax requirements that exist. You are responsible for understanding FICA taxes, unemployment, and federal and/or state income taxes (depending on which state you live in). When paying cash wages, ensure that you’re properly withholding and paying the correct amount of payroll taxes.
  • Understand wage and hour requirements. These impact how much employees must be paid and what time is considered compensatory.
  • Keep accurate records. Staying on top of your records is a general good business practice, but becomes essential when paying cash. Because cash doesn’t come with the same paper trail as direct deposit or a check, you need to count on accurate records. Keep track of the amount of wages paid, the payroll taxes withheld, and when you paid your employee. Having a strong system in place will keep you covered should any problems with an enforcement agency arise.
  • Follow similiar practices for employees and independent contractors. It’s common for small business owners to contract with independent contractors and the question about the best way to pay contractors pops up. Even though independent contractors operate differently from an employee, if you’re going to pay cash to contractors, it’s important you are following the similiar practices as mentioned above for employees. Contractor payments must be reported to the IRS. To report independent contractor wages use Form 1099-MISC to report wages annually and verify a taxpayer ID for independent contractors.

Bottom Line

Again, while it may not be illegal to pay employees cash, you may be taking on more risk than it’s worth. For an easier time processing payroll, you can turn to an accountant or bookkeeper or an online payroll service to help you out. Those options will help ensure that you are accurately following government guidelines to remain in compliance and that your employees receive accurate paychecks.

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This website contains articles posted for informational and educational value. SurePayroll is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, SurePayroll. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant. If you require legal or accounting advice or need other professional assistance, you should always consult your licensed attorney, accountant or other tax professional to discuss your particular facts, circumstances and business needs.