How Do You Pay Employees Cash Legally?

If you manage a cafe or another business that takes cash payments, you’ll naturally get many customers paying you in cash. 

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It may sound easy to pass that cash on to your employees as their salaries. It’ll spare you from the extra work of depositing the money in your bank and doing a bank transfer or check payment.

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But is it legal?

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Let's answer that burning question right away. 

​​Is It OK to Pay Employees in Cash?

Yes, it’s okay to pay your employees in cash if you comply with regulations from the Internal Revenue Service (IRS) and the Department of Labor (DOL). It’s also legal to pay your 1099 employees (independent contractors) in cash. 

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However, paying your employees or contractors under the table, without providing a pay stub or paying taxes, is illegal. And it can result in penalties, fines, and jail time. 

How to Legally Pay Employees in Cash

The main issue with cash payments is that they don't leave an innate transaction record like direct deposits or checks. But that doesn't mean you can't create manual records to comply with labor laws and back up your claims during IRS audits. 

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Let's see what you need to do to pay with cash. 

#1. Keep Payment Records

Say you pay an employee and don’t record that payment. While doing your accounts, you’ll have difficulty figuring out how much you paid and when. If you miss recording salary payments, your payroll tax calculation could be wrong. You might pay less tax than due, potentially leading to penalties. 

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There’s also a chance your workers might claim that they didn’t receive correct employee wages or overtime pay. This could lead to disagreements and even lawsuits. So, it’s best to keep an accurate record of when and how much you pay an employee in cash. 

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In general, it’s a good practice to provide your employees with a detailed pay stub containing the following information:

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• Gross wages
• Total hours worked
• Regular pay rate 
• Deductions—including taxes, contributions to savings, and charitable donations 
• Net wages
• Pay period
• Social Security number
• Employee and employer contact details

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The federal law doesn’t require business owners to issue pay stubs. Still, there are state-specific laws on pay stub requirements, and having a paper trail makes it much easier to cruise through any IRS audits. 

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Although you have to report tips so they can get taxed, the IRS doesn’t mention that employers need to include this money on pay stubs. Still, it will be easier for you to do so. That way, you can quickly figure out exactly how much to deduct in taxes.

#2. Follow a Regular Payment Schedule 

A regular payment schedule will help you comply with your state’s payday requirements. It will also make it easier to accurately pay your employees for their regular working hours and overtime.  

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Why is that?

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Well, say a plumbing business pays its employees in cash after every project, and the payment date varies based on the project’s length. If a project takes two months to complete, the business won’t pay its employees for two months. 

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But in doing so, the business will violate its state’s payday regulations. Several states have preferred payment frequencies, ranging from weekly to monthly. 

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And let’s say that in that two-month project, one of the hourly workers puts in 50 hours in the last week of the project and 10 hours in all other weeks. 

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If the business calculates the total time as 120 hours and pays for those hours at the regular rate, it’ll go against the Fair Labor Standards Act (FLSA)’s overtime pay mandate. According to FLSA, any non-exempt employee who works more than 40 hours in a workweek is eligible for overtime pay of at least 1.5 times the standard pay. 

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In other words, for that last week, when the employee worked 50 hours, those extra 10 hours should have been billed at time and a half. 

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So, stick to a regular pay period to comply with the payday requirement and overtime pay mandate.

#3. Calculate and Pay Taxes

While paying with cash helps you avoid those time-consuming bank trips, you still need to pay the right paycheck taxes and submit the required tax forms.  

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As an employer, you need to withhold the following taxes from your employee’s cash wages:

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• Federal income taxes
• State income taxes
• Federal Insurance Contributions Act (FICA) taxes—Social Security and Medicare taxes
• Federal Unemployment Tax Act (FUTA) taxes
• State Unemployment Tax Act (SUTA) taxes

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The IRS also requires every tipped employee to report their tips to their employer unless the total amount is less than $20 for a month. You would then need to withhold taxes on those tips. 

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To report how much tax you withhold, you need to file different tax forms, like Form W-2 and Form 1099-NEC. 

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Besides that, you also need to distribute an employee’s Form W-2 or an independent contractor’s 1099-NEC to them by Jan. 31 of the following year so that they can submit their tax returns. Missing the deadline means you could be hit with a $50 to $290 penalty for each employee you late file.

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Keeping a tab on these taxes can be challenging if you've got several employees. You can instead rely on a software solution like Hourly, which calculates and pays all your payroll taxes for you.

#4. Get Acknowledgment of Payment from the Employee

Imagine you pay an employee, but a few days later, they claim they haven’t received the payment. Since a cash payment doesn't leave a paper trail, there’s no way to disprove this claim. 

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What can you do to avoid this?

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When paying by cash, it’s best to collect a signed salary receipt from your employee with the following information:

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• Your company’s name and address
• Employee name and address
• Social Security number
• Salary amount
• Payment date
• Payment period

Following these business practices will help you stay out of trouble when paying via cash. 

Why Would an Employer Pay Cash?

Many small businesses (like restaurants, dry cleaners, janitorial services, and salons) prefer to pay in cash because: 

• They don’t have a business bank account separate from their personal account.
• Their employees prefer to be paid in cash.
• They pay their employees every week or even daily and don’t want to deal with keeping track of checks or electronic payments.
• It cuts down on bank trips to deposit cash for paychecks
• It saves them time since they don’t have to write checks or transfer money between accounts.

What Are the Disadvantages of Paying in Cash?

Cash payments may seem easy to handle, especially when you start your business. But they come with a few disadvantages. 

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• Room for errors: You can’t easily track cash payments. So, you might miss recording a payment or miscalculate overtime. These payroll mistakes can result in inaccurate tax payments, which can come back to haunt you in an IRS audit. 
• Issues around irregular payments: Random cash payments can violate your state’s minimum payment frequency mandate. They might also result in the wrong calculation of overtime payments, resulting in labor law violations.  
• Chance of violating the pay stub mandate: Some states mandate that you should give your employee a pay stub for every payment. If you pay by cash randomly, creating a pay stub every time is difficult, and you might even forget to create a pay stub. 
• Withdrawing large amounts of money: If you withdraw more than $10,000 from your bank account to pay your employees, it may lead to an IRS audit.
• Issues with safekeeping: Keeping large amounts of cash at the site comes with the risk of theft and robbery. 

Cash vs. Cashless Payments: What’s Better?

Paying in cash is better if you have a regular influx of cash and don't have a lot of employees. For instance, if you run a cafe with a couple of employees, you might be able to pay cash without the hassles and possible errors. 

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However, as your business grows or you get more employees, keeping tabs on their tax deductions and managing their payroll with cash payments can get complicated. So, you’ll probably want to move on to cashless payments. 

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As an employee, getting paid in check is better for you as it leaves a transaction trail. But if you prefer to get paid in cash, that’s okay as long as your employer pays the right amount of taxes and covers insurance premiums for workers’ compensation insurance. Many states, like Texas and California, provide online verification tools for your employer’s workers’ compensation insurance coverage.

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Put simply, paying in cash has several disadvantages, but if you have a solid reason to pay in cash, you can still do it legally. 

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All you need to do is be diligent and follow the best practices.