So what, I pay an occasional contractor in cash? What is the big deal?
Paying Cash To Contractors
Just because you can doesn’t mean you should. While paying a contractor with cash is perfectly legal, there are several reasons why doing so may result in problems that far outweigh the convenience of handing someone cash and wishing them well.
Paying someone in cash may seem quick and easy but doing so can expose you to various problems. For starters, cash is not traceable. That can make it very difficult to prove that you paid for an expense and can be challenging to prove in the case of an audit. Additionally, an unscrupulous contractor could decide to turn around and claim that you did not pay for their services. Having settled in cash would make it extremely difficult to counter such a claim.
Some contractors might try to submit an unemployment claim and list you as an employer. If you did not obtain W9 and don’t have a contract, how will you prove that the worker was paid and was an independent contractor?
Just because you elect not to ‘claim the deduction’ does not relieve you of your responsibility to report such payments, including on the tax return. Practice owners are required to report all income and expenses, including those received or paid in cash. It is not optional! And it is important to note that the same reporting rules apply at both the business and personal levels. For example, it is common for people to contract work around their homes for childcare, elder care, lawn care, etc. The fact that these are likely personal expenses does not exempt them from reporting.
It is also essential to obtain W9s from independent contractors so that 1099-NECs can be issued, if required, at the end of the tax year. However, cash payments tend to be made hastily before a W9 is obtained. It is usually harder to get W9s after payment is made rather than prior. Without obtaining a W9, your veterinary clinic might be required to perform backup withholding for potential federal taxes. Without a W9 or issuing the contractor a 1099-NEC, the IRS might disallow the deduction of the contracted expense, and worse yet, access penalties against your practice.
Some contractors may also request payments in cash to avoid their tax liabilities, which means they will likely avoid providing appropriate tax documentation. Paying contractors in cash makes substantiating payments more difficult for both parties and can prompt officials to inquire whether cash payments are being received or paid illegally (under the table). You could be charged with tax fraud if you knowingly facilitate such activity.
Various risks are associated with making cash payments to contractors, including fraud, liability, and tax risks. Although it is legal to pay contractors in cash, these risk factors should encourage you to pay contractors by another method to provide a paper trail. If you end up paying the contractor with cash, ensure you get a receipt and have a W9 on file. Due to mentioned risks, we highly encourage you to make all payments in forms other than cash. Certainly, it’s not worth risking your reputation or even your practice over!