Paying Workers Cash: The Tax Risk and How to Do It Right in 2026

Short answer: Paying workers cash is legal, as long as you report it and withhold on it. Cash is just a payment method. The tax risk shows up when the payment goes unreported, unwithheld, and undeposited. Run cash through the same steps as a paycheck — compute the withholding, deposit it, put it on the 941, issue the W-2, keep a signed receipt — and you are on the legal side of every one of the cases below.

For the wider picture on running the money side of a trade business, start at our contractor tax planning hub. This post handles one question: how to pay crew in cash without stepping over the line.

Is paying workers cash legal?

Yes. There is no federal law, no IRS rule, and no state statute that bans paying a worker with paper currency instead of a check or direct deposit. The IRS does not care whether you hand a crew member $900 in bills on Friday or push $900 to their bank account. It cares whether that $900 shows up on the right forms with the right taxes taken out and sent in.

The reason cash has a reputation is that it is easy to hide, and the cases that make the news are always about the hiding. Look at the anchor case for this whole topic. Melesio Gomez-Rivera ran a residential construction company in the Portland area. Contractors funneled roughly $192 million in payroll through a check-cashing business to pay crews under the table, and false Forms 941 — the employer's quarterly payroll-tax return — were filed to cover the tracks. In 2023 a federal judge handed down 30 months in prison and $29.9 million in restitution (U.S. v. Gomez-Rivera, D. Or. 2023).

Read the charge closely. The crime was the concealment machinery — the check-cashing runs and the false returns — not the use of cash. Nobody went to prison for handing out bills. They went to prison for running $192 million of wages through a laundry and lying about it on the 941. Cash wages with proper withholding, deposits, and a W-2 are indistinguishable from direct-deposit wages once they hit the IRS. The payment method is irrelevant to the tax treatment. The reporting is the whole game.

What is the actual tax risk of paying workers cash?

The risk is not the cash. The risk is skipping a step that you would never skip on a normal paycheck. There are two ways that happens, and they map to the type of worker.

If the worker is an employee and you pay cash without withholding, the IRS treats it exactly the same as paying by check without withholding. You still owe FICA — the Social Security and Medicare tax, where the employer share is 7.65% of wages up to the $184,500 Social Security wage base for 2026, then 1.45% for Medicare with no cap above that. You still owe the federal income tax you were supposed to hold back, whether or not you actually collected it from the worker. You still owe FUTA — the federal unemployment tax, a headline 6.0% on the first $7,000 of each worker's wages that drops to a net 0.6% once you take the full state credit. None of that goes away because you paid in bills. It just goes unpaid, and unpaid payroll tax is the fastest way to turn a bookkeeping shortcut into a real problem.

If the worker is a contractor and you pay cash without a 1099, the risk moves to the paperwork side. That is where the second case lives. In Kurek v. Commissioner (T.C. Memo. 2013-64), a Brooklyn remodeler lost his Section 530 safe-harbor protection — Section 530 being the rule that shields a business from reclassification penalties when it has consistently treated workers as contractors and filed their 1099s — for one reason: he never filed his workers' 1099s. Not because of how he paid. Because of what he failed to file. The paperwork decided the case, and the paperwork is the cheapest part.

So the actual tax risk of paying workers cash is the same risk you would run paying them any other way and cutting the same corner. Cash does not create the exposure. Not reporting does.

Cash to an employee vs. cash to a contractor: what is the difference?

Before the how-to, here is the fork in the road. The payment method is identical. Everything around it is different, and which set of rules applies depends on whether the worker is your employee or an independent contractor. If you are not sure which one a given crew member is, that classification question is worth settling first — see employees vs. 1099 subcontractors and 1099 vs. W-2 for the full breakdown.

A couple of the terms above, defined once. A 1099-NEC is the form that reports what you paid a contractor for the year; the IRS gets its own copy and matches it against the contractor's return. A W-9 is the one-page form you collect from every sub before the first dollar changes hands — it gives you the legal name and taxpayer ID number you will need at 1099 time. Get the W-9 up front, every time, because chasing it in January is how good subs turn into missing 1099s.

How do I pay workers cash the right way?

Answer first: run the cash through the exact same pipeline you would use for a check. Nothing about the currency changes the steps. Here is the sequence for an employee you pay in cash.

1. Collect the paperwork before the first payday. Get a completed W-4 and confirm work eligibility. No exceptions, no "we'll sort it out later."
2. Compute the withholding on the gross. Figure federal income tax withholding from the W-4, plus the employee's 7.65% FICA share, plus any state tax. What you actually hand over in cash is the net — gross minus everything you held back.
3. Set aside the employer share the same day. On top of what you withheld from the worker, you owe the employer's 7.65% FICA and 0.6% net FUTA. Move that into your tax account the moment you pay, so it is there when the deposit is due.
4. Deposit the payroll taxes on schedule. The combined withholding and employer taxes get deposited to the IRS on your assigned schedule (monthly or semiweekly). This is the step the prosecuted cases skipped. Do not skip it.
5. Report it on the Form 941. Every quarter, the 941 reports the wages you paid and the taxes you withheld and deposited. Cash wages go on the 941 the same as any other wages.
6. Get a signed pay receipt every time. Because there is no canceled check or bank record, the signed receipt is your proof of payment. List the date, gross, each deduction, and the net handed over, and have the worker sign it. Keep it with the payroll record.
7. Issue the W-2 in January. Total up the year's cash wages and withholding on the W-2, same as you would for a salaried employee.

For a contractor you pay in cash, the pipeline is shorter but the discipline is the same.

1. Get the W-9 before the first payment. Legal name, business name if any, and TIN. If they will not give you a valid TIN, you are required to apply backup withholding — hold back 24% of the payment and send it to the IRS — so it is cheaper for everyone to get the W-9 done up front.
2. Pay the full amount — no withholding. Contractors handle their own taxes, so you pay the agreed fee in cash with nothing held back (unless backup withholding applies).
3. Log the payment and get a signed receipt. Same rule as employees: with cash there is no bank trail, so the signed receipt and your books are the record.
4. File the 1099-NEC if you paid $2,000 or more. For 2026 the threshold is $2,000. Hit it and you file. The when to give a contractor a 1099 post walks the edge cases, but the rule of thumb is: at or over the threshold, file it. Kurek is the whole reason this step is non-negotiable.

One habit that ties both lists together: sweep 25 to 30 cents of every net dollar into a separate tax account the day you take a draw, so the employer FICA, the FUTA, and any withholding you owe are already funded when the deposit comes due. If quarterly estimates are also part of your picture, the quarterly taxes post covers how those fit alongside payroll deposits.

What happens if I already paid cash without reporting it?

Answer first: the fix is to start reporting, and the sooner the better. The exposure grows the longer the omission sits, so getting current is almost always cheaper than waiting to be found. In Kurek, the deciding factor was the missing 1099s — the protection was lost solely because the paperwork was never filed. That cuts both ways: filing the paperwork is exactly what keeps the protection in place.

If the unreported payments were to employees, that means catching up the withholding and employer taxes, filing or amending the affected 941s, and issuing corrected W-2s. If they were to contractors, it means filing the 1099s you should have filed and, going forward, collecting W-9s before the next payment. This is a spot where a practitioner earns their fee, because the order of operations and the reasonable-cause story matter. The point to hold onto is that the door out is reporting, not more concealment — the concealment is the only thing that turned the anchor case into a prison sentence.

Does paying cash mean I lose the tax deduction?

No — not if you documented it. Cash wages and cash contractor payments are deductible business expenses just like any other, and the payment method has no bearing on deductibility. What kills the deduction is the absence of proof. With a check there is a bank record; with cash there is only what you wrote down. That is the entire reason the signed pay receipt and the contemporaneous log matter so much. A deduction you cannot substantiate is a deduction you can lose in an audit, and cash raises the substantiation bar because you supplied the paper trail yourself. Document it properly and cash-paid labor deducts the same as check-paid labor.

Paying part of your crew in cash and want to be sure every step is covered? We set up the withholding, deposit, 941, W-2, and 1099 workflow so your cash payroll is as clean on paper as a direct deposit. Book a meeting with our team here.