Paying workers under the table is a risky business practice. I can understand the appeal, though: employers don’t have to collect and pay a share of worker’s State and Federal income taxes, FICA, Medicare, Workers Compensation, or any benefits that on-the-books employees might be entitled to, like health insurance or paid vacation. Workers get “tax-free money” (or so they think).
Risk Is Real
For employers, the risk of getting caught is low. Or is it? What happens if an under-the-table worker gets injured on the job and files a Worker’s Compensation claim? Or is fired, and wants to apply for unemployment? Perhaps they must prove income to get a car loan? Or needs to justify living expenses to qualify for a student loan? A mortgage? Auto insurance? What if an ex-spouse reports a worker’s off-book money so they can get an increase in child support payments? Workers who spend years getting paid under-the-table and do not report the income will find that they have figuratively shot themselves in the foot when the time comes for them to collect Social Security, Medicare, Unemployment, or Workers Compensation.
Generally, those who accept off-book payment for their work just want the money and aren’t going to be too demanding when it comes to your record-keeping. Neither are they likely to inform the IRS of an employer’s illegal bookkeeping practices; if they do, they will be liable for paying self-employment and income taxes on their unreported income. Sometimes, though, workers become whistle-blowers because they have a grudge against an employer. Then, everyone involved loses.
Payments: Better Late Than Never (To Start)
Clearly, the best approach to paying workers is to do so legally. But what does one do if paying
under-the-table has been a long-standing practice? How can a dealer climb out of that hole and get back on track? Here are six tactics that can mitigate the problem.
1. Start paying on-book now. If you don’t already have them, apply for state and federal tax identification numbers. Then, begin paying taxes every quarter. Sign-up forms are available on your state’s official website and federal forms are found on the IRS website. If the paperwork involved in payroll processing seems burdensome, hire a payroll service. Most of them are very affordable and are worth every penny you pay them.
2. Accept that you may need to give affected workers a raise (about 15 percent, usually). If their take-home-pay is about the same as their former cash payment, they will be less likely to stir up trouble.
3. Discus the situation with your worker. Explain how payroll deductions work to their benefit, including:
- Unemployment compensation: If laid off through no fault of theirs, workers may receive up to 50 percent of their salary for up to six months. This benefit is paid through insurance purchased by the employer.
- Social Security and Medicare: Retirees receive a monthly payment based on how much money they pay into the Social Security system. Employers match a workers’ contributions dollar-for-dollar. As a rule of thumb, an employer’s contributions may boost the amount of a retiree’s benefit by as much as 500 percent. Money paid under-the-table doesn’t count toward Social Security benefits.
- Healthcare subsidies: The Affordable Care Act requires individuals to have health insurance or pay a fine. On-book employees may qualify for a premium subsidy when they purchase a policy through the ACA Insurance Marketplace.
- No more paying self-employment taxes or making quarterly tax deposits. It’s doubtful that your worker even knows that they are required to do this. They won’t be happy about having accepted off-book payments when they find out. But, it certainly provides motivation to get them onto payroll and that you will be making matching payments and filing the taxes on their behalf.
Research Payment Approaches
4. Consider classifying your worker as an independent contractor (IC). IC agreements should be in writing and detail the nature of the working relationship. Furthermore, using an IC gives an employer much less control over a worker’s schedule and activities and may not suit your situation. Before offering IC status to a worker, be sure you understand how such agreements work; see my June 9, 2015 Behind the Gavel column “Slippery Slope: Employee mis-classifications leading to crackdown.”
5. If you have been paying off-book for years, understand that you are responsible for reporting and remitting your share of the taxes on all the money that you paid under-the-table back to “day one” for each off-book worker. Seek the advice of an attorney to evaluate your risks and potential liabilities. In addition to taxes, interest, and penalties ($250,000 for individuals and $500,000 for corporations), employers may be subject to criminal prosecution and face up to five years in prison for tax evasion.
Though anecdotes of IRS abuse abound, I am told that they are primarily interested in bringing non-compliant employers into compliance and collecting the back taxes and penalties. But, don’t mistake my opinion for legal advice.
6. Refine your accounting system. If you’re one of the many antique dealers who use single-entry bookkeeping on Excel spreadsheets, you’re leaving profits on the table and throwing away your cash. A good accounting system will allow you to track every possible deduction, including payments you make on behalf of your employees.
Maximize and Take Initiative
If you’re not maximizing depreciation and using inventory write-downs, chances are good that you are showing too much profit and paying too much in personal property and income taxes. Plus, you’re unable to manage your business “by the numbers,” because you don’t have any reliable numbers to base decisions on. Often, a good accounting system (or a good accountant) will enable you to find to money to pay back taxes, put your off-book workers on payroll, and become IRS compliant.
Finally, the key to solving a tax problem is to take the initiative. If an offender waits until someone turns him in, criminal charges are more likely. If you fall into this category, determine the scope of the problem, get some legal advice, and act.