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.