Many contractors believe that paying employees in cash saves them taxes and paperwork. When you add everything up, the savings are small and the risk is big.
An audit, a fine or an uninsured accident can cost more than what you saved. Here we look at it with numbers.
In short
- Paying in cash is not illegal; what is illegal is not withholding, not reporting and not having insurance.
- In the example, the “savings” from not paying formal payroll are about $8,100 a year per employee.
- A fine for not having workers’ comp can be bigger than that savings and can come with a stop-work order.
- Without payroll or records, you lose the deduction for what you paid.
- If you pay in cash because you cannot afford more, the real problem is your prices.
Paying employees in cash: what is true and what is not
True: you can pay in cash if you do it through payroll, with withholding and a pay stub.
False: that paying cash “under the table” frees you from taxes. If the person is your employee, you must withhold, report and pay payroll taxes (IRS).
You must also have workers' compensation (workers' comp) insurance. That requirement exists even if the pay is in cash.
What you "save" vs. what you risk
Example: a helper earns $1,000 per week, or $52,000 a year. These are the costs you would stop paying with a cash payroll.
| Cost on formal payroll | Per year (approx.) |
|---|---|
| Employer Social Security and Medicare (7.65%) | $3,978 |
| Workers’ comp (example: $8 for every $100 of payroll) | $4,160 |
| Total of the “savings” if you don’t pay it | about $8,138 |
The workers' comp rate depends on your trade and your insurer. The example is only an illustration. Also, formal payroll carries unemployment taxes, which vary and are not added up here.
| What you risk | How much it can cost |
|---|---|
| Penalty for no workers' comp (Labor Code 3722) | $1,500 per employee or twice the premium, whichever is greater |
| Stop work order | Job stopped until you have insurance |
| Intentional misclassification (Labor Code 226.8) | $5,000 to $15,000 per violation |
| Back payroll taxes | Taxes, penalties and interest for several years |
| A serious accident without insurance | Medical bills and wages you are responsible for |
In the example, double the premium would be $8,320. That penalty alone is already more than the “savings” for the whole year.
Risk 1: audits, taxes and penalties
The EDD (Employment Development Department, California's employment agency) can review your business if a worker files for unemployment or gets hurt. If it finds cash payments, it can charge you back payroll taxes, with penalties and interest.
In construction, someone who works for you without their own license is usually considered your employee (EDD). That is why paying in cash doesn't protect anyone.
To understand when someone is an employee, read Employee or contractor? 5 signs and the ABC test.
Risk 2: an accident without workers' comp
In construction, accidents happen. A fall from a ladder can cost a lot in medical bills and lost wages. Without insurance, you pay for everything.
The state can also issue a stop order and shut down your job. That penalty for having no workers' comp adds to the costs of the accident (DIR).
See the details in workers' comp in California.
Risk 3: you lose deductions
What you pay for labor is an expense you can subtract from your income. But you must be able to prove it, and the IRS requires you to keep payroll records (IRS: employment tax recordkeeping).
If you paid $52,000 in cash with no records, it is very hard to deduct wages in an audit. You could end up paying taxes on money you already spent.
Risk 4: you lose good workers
The best workers want a pay stub. They need it to rent, buy a car or ask for a loan.
If you do not give it to them, they go to someone who does. Paying workers in cash with no paperwork costs you a steady crew.
The root cause: prices that do not cover your costs
It is often paid in cash because, with formal payroll, the job leaves no profit. That means your prices are too low.
The fix is to quote with all your real costs, including full labor. Read profitability for contractors to figure out your profit per job.
Common mistakes when paying in cash
These mistakes are common among contractors who pay cash. Check if any of them sound familiar.
- Paying only part of the wages “off the books” and the rest by check.
- Not giving a pay stub or recording who received how much.
- Treating a helper as a subcontractor just to avoid payroll.
- Assuming the job-site insurance covers everyone who works there.
- Waiting for a fine to arrive before getting your paperwork in order.
They all have the same root: there's no record of what happened. Without a record, you can't defend your payments to anyone.
Imagine a month with and without records
Imagine you pay three helpers in cash for a month. This is an illustrative example, not a real case.
One helper gets hurt on Thursday and another files for unemployment the next month. Nobody has a pay stub and you have no list of payments.
Now imagine the same month with payroll. Each payment has a date, an amount, withholdings, and insurance. If an audit comes, you hand over documents instead of explanations.
How to keep your payments up to date with bookkeeping
Bookkeeping (keeping your books up to date) doesn't replace payroll, but it gives you order. Every payment to the crew should be recorded with the date and the job.
With that order, you know what your labor really costs. That way you bid better and see if the job leaves a profit. Learn about the ODC bookkeeping service.
Payroll taxes are handled by your payroll service and your tax preparer. ODC doesn't prepare them, but we leave your books ready for them.
How to move to formal payroll step by step
If you pay in cash today, these are the steps to get organized. Your payroll service with partners can help with several of them.
- Register as an employer with the EDD.
- Hire a payroll service.
- Get a workers' comp policy.
- Fill out the I-9, W-4 and DE 4 with each employee.
- Adjust your prices to cover the real cost of labor.
- Talk to a professional about how to handle past payments.
If you have been paying in cash for years, do not fix it on your own. Every case is different and depends on your situation.
What to do now
- Add up how much you paid in cash last year.
- Use the table to figure out what it would cost on formal payroll.
- Ask for a workers' comp quote for your trade.
- Schedule a review to move to payroll.
FAQ
Is it illegal to pay in cash?
No. What is illegal is not withholding, not reporting and not having insurance. You can pay in cash if you do it through payroll, with a pay stub, tax withholding and workers' comp. What you cannot do is use cash to avoid those duties to your employees.
How much is the fine for not having workers' comp?
In California it can be $1,500 per employee, or double the premium you should have paid if that amount is higher (Labor Code 3722), plus a stop order that halts work until you have insurance. The final amount depends on your case.
Can I deduct what I pay in cash?
Only if it is a real business expense and you can prove it. Without payroll or records, it is very hard to defend in an audit. That is why you should keep pay stubs, contracts and proof of each payment, and ask your tax preparer.
When to talk to a professional
This article is a general guide. If your case involves a letter from the IRS, the FTB or the EDD, a lawsuit, an accident or a change in your business structure, talk to a lawyer, a tax preparer (CPA or enrolled agent) or the official agency. Every case is different.
How ODC helps you
At Oficina del Contratista we keep your bookkeeping up to date: we record your income and expenses, reconcile your accounts and explain your reports in Spanish. For taxes, payroll, insurance or legal matters, we connect you with independent partners; they provide those services, not ODC. See all services.
Want to move to formal payroll? We connect you with a payroll partner and organize your books. Message us on WhatsApp.
References
- California Labor Code 3722 — Penalty for not having workers' comp and stop order
- DIR – Employer information — Employer duties for workers' comp
- EDD – Employment status — Who is considered an employee
- IRS – Employment tax recordkeeping — Payroll records
- IRS – Understanding employment taxes — Employer payroll taxes, including 7.65%
- California Labor Code 226.8 — Penalties for intentional misclassification
Runs Oficina del Contratista, a Spanish-language bookkeeping service for contractors. Has experience in management, sales and construction consulting.
Important notice: this article is educational and informational only; it is not legal or tax advice. It may contain errors or be out of date. Before making decisions, check it with a licensed expert or attorney.
