Wages paid in cash are taxed exactly like wages paid by direct deposit or check: the employer must withhold federal income tax and FICA, deposit those amounts with the IRS, and issue a W-2, and the employee must report the wages on their return. The rules on cash pay taxes don’t bend because the money changed hands as currency. What creates the trouble people usually associate with cash — the audits, the penalties, the missing W-2s — is when either side skips the withholding and reporting steps that would apply to any other paycheck.
Legal Cash Payroll Versus Under-the-Table Pay
Federal law defines wages as all compensation for services, regardless of the form the payment takes.1Office of the Law Revision Counsel. 26 U.S. Code 3401 – Definitions Cash run through a proper payroll system, with taxes withheld and a W-2 issued at year-end, is entirely legal.
“Under the table” describes the other version: cash handed over with no withholding and no reporting. That arrangement violates federal tax law even when both sides agree to it. The employer faces failure-to-withhold, failure-to-deposit, and failure-to-report penalties. The employee still owes income tax on the money and can be penalized for not reporting it. The dividing line is not the currency. It is whether the taxes get handled.
What an Employer Must Withhold on Cash Wages
An employer paying in cash calculates withholding the same way as for any other payroll. Federal income tax withholding starts from the employee’s Form W-4.2Internal Revenue Service. Topic No. 753, Form W-4, Employees Withholding Certificate On top of that, the employer withholds the employee’s share of FICA and pays a matching employer share.
- Social Security: 6.2% from the employee and 6.2% from the employer, for a combined 12.4%. In 2026, this applies only to wages up to $184,500.3Social Security Administration. Contribution and Benefit Base
- Medicare: 1.45% from the employee and 1.45% from the employer, for a combined 2.9%, with no wage cap.4Internal Revenue Service. Topic No. 751 – Social Security and Medicare Withholding Rates
Combined FICA runs 15.3% up to the Social Security wage base, split evenly at 7.65% each. An additional 0.9% Medicare tax applies to employee wages above $200,000 in a calendar year ($250,000 for married couples filing jointly). The employer withholds the extra 0.9% once the employee’s wages pass $200,000, and there is no employer match on that portion.5Internal Revenue Service. Topic No. 560, Additional Medicare Tax State and local income tax withholding rules apply on top of federal, depending on where the work is performed.
Depositing, Reporting, and the Penalty for Skipping
Withheld taxes and the employer’s matching FICA are deposited with the IRS through the Electronic Federal Tax Payment System, a free Treasury service.6Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System Each quarter, the employer reports total wages and withholding on Form 941.7Internal Revenue Service. About Form 941, Employers Quarterly Federal Tax Return Each January, the employer must furnish a W-2 to the employee by January 31 showing wages paid and every tax withheld.8Social Security Administration. Deadline Dates to File W-2s
Missing a deposit deadline draws a tiered penalty: 2% of the unpaid deposit for 1–5 days late, 5% for 6–15 days, 10% for more than 15 days, and 15% if the deposit is still unpaid more than 10 days after the IRS issues a notice.9Internal Revenue Service. Failure to Deposit Penalty
The bigger risk is personal. The income tax and FICA an employer withholds are held in trust for the government. When a person with authority over the business’s finances willfully fails to hand those funds over, the IRS can assess the Trust Fund Recovery Penalty equal to 100% of the unpaid amount against that individual, and it survives bankruptcy and corporate dissolution.10Office of the Law Revision Counsel. 26 USC 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax This is what usually catches up with employers who pay cash off the books.
How Employees Report Cash Wages
If your employer runs cash payroll properly, filing is ordinary. The W-2 figures flow onto your Form 1040 the same as any other job. Check the wages and withholding on your W-2 against your own records before filing, because the IRS matches W-2 data to your return electronically.
If You Never Get a W-2
You still owe tax on the income. If January 31 passes without a W-2, contact the IRS, which can send a formal request to the employer. You can then file using Form 4852, a substitute wage statement on which you estimate your gross wages and withholding from pay stubs, bank deposits, or other records and explain why the W-2 is missing.11Internal Revenue Service. Using Form 4852 When Missing the Form W-2 or 1099-R If you suspect your employer has been treating you as an independent contractor to avoid payroll taxes, Form SS-8 asks the IRS to determine your correct worker status.12Internal Revenue Service. About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding Cash income must appear on your return no matter what the employer files.
Cash Tips
If you earn $20 or more in cash tips in a calendar month, you have to report them to your employer so income tax and FICA can be withheld. Tips you didn’t report to the employer still go on your tax return using Form 4137, which calculates the Social Security and Medicare tax owed on those amounts. Failing to report tips to your employer when required can carry a penalty equal to 50% of the Social Security and Medicare tax owed on the unreported tips.
Cash Paid to Independent Contractors
When a business pays an independent contractor in cash, nothing is withheld. The contractor owes everything at filing time.
For 2026, a business must issue Form 1099-NEC to any independent contractor paid $2,000 or more during the calendar year. The threshold rose from $600 for payments made after December 31, 2025.13Internal Revenue Service. Form 1099-NEC and Independent Contractors The contractor reports all payments received, whether or not a 1099 arrives.
Contractors owe self-employment tax at a combined 15.3%, covering both the employer and employee shares of Social Security and Medicare.14Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) It is figured on Schedule SE with Form 1040.15Internal Revenue Service. Topic No. 554, Self-Employment Tax Half of the self-employment tax is deductible when figuring adjusted gross income. Business income and expenses go on Schedule C, and the resulting net profit feeds the SE tax calculation.16Internal Revenue Service. About Schedule C (Form 1040)
Because no one is withholding, contractors generally have to pay estimated taxes quarterly using Form 1040-ES. The requirement kicks in if you expect to owe at least $1,000 after withholding and refundable credits.17Internal Revenue Service. Estimated Taxes The 2026 due dates:
- April 15, 2026, for income earned January through March
- June 15, 2026, for income earned April through May
- September 15, 2026, for income earned June through August
- January 15, 2027, for income earned September through December18Internal Revenue Service. Estimated Tax
Underpaying or missing a quarter triggers an underpayment penalty that accrues on the shortfall.19Office of the Law Revision Counsel. 26 U.S. Code 6654 – Failure by Individual to Pay Estimated Income Tax Without automatic withholding, it is easy to spend the money and face a large April bill with penalties attached.
Paying a Nanny, Housekeeper, or Caregiver in Cash
Cash pay for household workers is common and comes with its own threshold. If you pay a household employee $3,000 or more in cash wages during 2026, you must withhold and pay Social Security and Medicare taxes on those wages.20Internal Revenue Service. Publication 926 (2026), Household Employers Tax Guide Once you cross the $3,000 line, every dollar of that year’s cash wages to that employee is subject to FICA, not just the amount above the threshold. Household employers report the taxes on Schedule H, filed with their personal Form 1040.
Recordkeeping When Payroll Is Cash
Cash payroll has no automatic bank record, so the paper trail has to be built by hand. The safest practice is a signed, dated receipt from the employee each pay period showing the exact net cash amount received. Without that signature, the employer has no proof the payment was made, and the IRS can disallow the wage deduction on audit. Alongside receipts, provide itemized pay statements showing gross wages, each tax deduction, and net pay.
Federal law does not itself require pay stubs. The FLSA requires accurate records of hours worked and wages paid but doesn’t dictate the format or require giving anything to the employee.21U.S. Department of Labor. Fair Labor Standards Act Advisor – Are Pay Stubs Required Most states have their own pay stub rules with penalties for noncompliance, so an itemized statement with each cash payment is the safer default.
Two retention clocks run:
- Under the FLSA, payroll records must be kept at least three years, and supporting documents like time cards and schedules at least two years.22U.S. Department of Labor. Fact Sheet 21 – Recordkeeping Requirements Under the Fair Labor Standards Act
- Under IRS rules, employment tax records must be kept at least four years after the tax becomes due or is paid, whichever is later.23Internal Revenue Service. How Long Should I Keep Records
Keeping everything for at least four years satisfies both.
Overtime When Part of the Pay Is Cash
Cash wages count toward the regular rate of pay used to calculate overtime. Under the FLSA, the regular rate includes all compensation for employment unless a specific exclusion applies.24U.S. Department of Labor. Fact Sheet 56A: Overview of the Regular Rate of Pay Under the Fair Labor Standards Act (FLSA) An employer cannot pay a base rate by check and then hand over extra cash on the side without folding that cash into the overtime calculation. Total compensation for the workweek divided by total hours worked gives the regular rate, and time-and-a-half applies to hours beyond 40. When a cash portion is left out of that math, every overtime check for the employee is short, and the back wages accumulate.