I Am an Employer and I Pay My Workers in Cash. Is This a Problem with the IRS or FTB?

If you pay your employees in cash and do not document this expense and report it to the IRS and FTB, you will not be able to report it as a deductible business expense on your business tax return or the Schedule C on your 1040 tax return. While many see this as a way to stay off the IRS’ radar, this is an unrealistic and unsafe position to try and take. Bank interest, mortgage payments, professional licenses and general local interest in your business can lead to audits and other investigations. If these occur, you will have no documentary support of your employee expense and no defense against any position taken by the IRS.

If do file your file tax returns claiming your employees as a deductible business expense, this will not be substantiated by W2s or 1099s required to be filed by the IRS and will be “red flag” for an IRS/FTB audit.  If these occur, you will have no documentary support of your employee expense and no defense against any position taken by the IRS. You are, however, in a slightly better position as you have, at least,  shown some good faith and put forth an initial position.

There is also the possibility that you do report the cash income paid to the employee to both the IRS/FTB by means of W2s or 1099s. This is rare as most cash revenues are paid to employees to avoid having the employee (W2)/independent contractor (1099) tax.

If you find yourself needing representation before the IRS and you fit one of the above profiles, you are most likely better served by hiring a tax attorney as opposed to a CPA. CPAs are great, but they will want documentation that you may not be able to supply. Attorneys are better trained to deal with uncertainty and representing imperfect situations.