For the millions of American workers who have income and payroll taxes withheld from their paychecks, it's easy to understand the appeal of a job where you get paid in cash and, presumably, out-of-sight from the tax man.
For Lindsay Lohan, though, the dream of tax-free cash payments appears to be turning into a nightmare.
According to Fox News, the IRS is taking a hard look at the fees that Lohan receives for making appearances at certain events. Of particular interest is the fact that the celebrity always asks to be paid in cash.
With the IRS already having seized Lohan's bank accounts for unpaid taxes, the cash requests certainly have the appearance of trying to shelter income from tax authorities.
Dealing With Cash Businesses
Lohan's issues are extreme, but anyone who primarily does business in cash runs into the same issues. For businesses that receive cash, accounting for every single transaction is burdensome and time-consuming. Moreover, the temptation to pay workers under the table is particularly strong, as even bringing on part-time help as employees requires a huge amount of paperwork to satisfy state and federal requirements.
Meanwhile, employees who get paid in cash face similar dilemmas.
Even if you want to comply with the tax laws, it can be tough even to get the required tax forms from your employer -- and extremely difficult to put together tax returns and pay appropriate taxes with incomplete information. Moreover, if your employer pays you under the table, it's all too likely that you're not having taxes withheld from your check.
As a result, you may not only have a big tax bill to pay at the end of the year but also not get appropriate credit for your work in terms of calculating Social Security and other government benefits.
Don't Be Tempted
Those burdens make simply taking the cash and trying to stay below the tax man's radar seem easier. But the IRS has tools at its disposal to help it catch those who decide that a cash-based business is an opportunity for tax evasion.
For one thing, tax reporting requirements tell the IRS when one party in a transaction is playing fair and the other isn't. For instance, if an employer files a W-2 or 1099 form reflecting the amount it paid you, you'll get yourself into trouble if your own tax returns don't have a matching entry that verifies the employer's report.
Similarly, if you're a cash-based employer but your employees report getting income from you, you'll have a hard time justifying tax forms that don't produce enough profit to finance your workers' wages.
Watch Out for These Red Flags
There are several areas where cash payments are more likely to raise red flags:
If you have a nanny, babysitter, housekeeper, or other household employee, you may need to pay what's called the "nanny tax." In 2012, those who pay more than $1,800 for household services have to pay the employer's share of payroll and unemployment taxes. In addition, you have to withhold the employee's share of those taxes from his or her pay.
To evaluate businesses that primarily involve cash, the IRS has a variety of simple tests auditors use to estimate whether the figures you report pass muster. By looking at bank deposits, cash transactions, and even spending habits, an audit can easily uncover inconsistencies between amounts you report and what you're actually earning.
If you're a worker and receive money in cash, try to get a W-2 form after the end of the year if you're an employee, or a 1099 if you do work as a contractor. If you don't get one, IRS Form 4852 (opens a PDF) gives you the ability to provide your own figures in order to get proper credit for any tax withholding as well as retirement benefits.
These requirements may seem intimidating. You may feel tempted as a result to do whatever it takes to avoid an IRS audit, even if it means paying more in tax.
But don't let the fact that you deal largely in cash stop you from taking all the deductions you're entitled to receive. You'll need to be diligent in hanging onto receipts for expenses, but by making sure you have a paper trail documenting both your income and your expenses, you'll put yourself in the best possible position to survive an IRS audit if it comes.
Motley Fool contributor Dan Caplinger once had to rat out an employer who didn't report his pay. You can follow him on Twitter @DanCaplinger.
Learn From These Celeb Tax Mistakes
Getting Paid in Cash? Don't End Up Like Lindsay Lohan
Many celebrities have gotten smacked down for failing to paying taxes. Wesley Snipes actually landed in prison for his $17 million unpaid tax bill, while Nicolas Cage owed a seven-figure amount to the IRS. A host of others, including Lindsay Lohan, Pamela Anderson, and Christina Ricci, have faced liens or tax bills for more modest -- yet still sizable -- sums.
The two main reasons for us ordinary folks getting stuck with a big tax bill are that your paycheck withholding needs changing or that you have outside income that comes without having taxes withheld. In either case, even if you can't afford to pay when the bill comes due, ignoring the problem will eventually land you in an even bigger heap of trouble. Instead, take advantage of IRS programs that let you make affordable installment payments over time.
Part of what put Wesley Snipes behind bars was his conviction on three counts of failing to file tax returns by their filing date. In part, he relied on a bogus theory that all income taxes are unconstitutional as justification for his actions.
But a much more common problem many people run into is that they can't afford to pay their tax bill right away. The mistake they often make is to assume that they shouldn't file a return at all if they can't pay. In reality, the penalties for not filing your taxes are much more severe than if you file but can't payyour taxes all at once. So even if you don't have the money to send with your return, go ahead and file. It'll save you a ton of money -- and possibly jail time -- in the long run.
AccountingWEB recently took a look at some of the great swag that celebrities received at the Academy Awards. With sponsors handing out goodies including everything from jewelry to exotic safaris, the gift packages added up to as much as $75,000 in value. But the recipients have to report it all as taxable income.
You may never be so lucky, but even more modest prizes often get reported to the IRS. If you get a Form 1099 reporting the value of something you received as a prize or award, notincluding it on your tax form could trigger a red flag at the IRS.
One allegation that Nicolas Cage raised regarding his tax problems was that his business manager mishandled his funds and caused big losses that destroyed his finances. Similarly, Martin Scorsese and Al Pacino both blamed convicted adviser Kenneth Starr for their tax woes. Starr went to prison for fraud and theft from clients.
Still, no matter where you go or how much you spend for tax preparation, youbear final responsibility for making sure your tax returns are accurate. Reputable accountants will reimburse you for any penalties and interest that result from mistakes they make, but don't count on them. Instead, make sure you understand the positions your tax pro takes so that you can defend them if a question arises.
As you look at the hijinks of your favorite celebrities, be sure not to make the same tax mistakes they made. With a little common sense and some planning, you can learn from celebrity mishaps the easy way.
The American Opportunity tax credit, which replaced the Hope Scholarship credit in 2009, covers more years of college and offers bigger, better benefits to more taxpaying students or their families. Here's how the American Opportunity tax credit and Lifetime Learning credit, another helpful education tax credit, can help offset the rising cost of attending college.