September 9, 2022

Can You Pay Independent Contractors in Cash?

Key Takeaway

While paying independent contractors in cash is legal, it's not recommended due to compliance risks and contractor preferences. In our research, we found that 80% of workers prefer platforms with instant digital payments, so cash payments are a competitive disadvantage.

Key Terms

1099 Independent Contractor: Self-employed worker who provides services to businesses and is responsible for their own taxes and benefits.
W-2 Employee: Traditional employee with taxes withheld by employer and typically receives benefits like health insurance.
Form 1099-NEC: Tax document required by the IRS to report non-employee compensation of $600 or more annually.
Audit Trail: Documented record of all financial transactions that can be verified and traced for compliance and tax purposes.
Digital Disbursements: Electronic payment methods that transfer funds instantly and create automatic documentation for all transactions.

Paying independent contractors in cash might seem like the simplest option, but its important to understand the rules before you hand over an envelope of bills. The IRS doesnt care how you payit cares how you report it. We'll break down everything you need to know about paying 1099 independent contractors in cash.

Is Paying Independent Contractors in Cash Illegal?
Paying independent contractors in cash is NOT illegal.
However, it's not a great business practice for a number of reasons.

What Makes Paying Independent Contractors Unique?

Paying independent contractors is different than paying W-2 employees. The IRS has specific guidelines on how to classify workers as W-2 or 1099we have a whole blog on it, too!

=� W-2 Employees

Tax withholding: Employer withholds taxes from paychecks
Benefits: Typically receive health insurance and other benefits
Tax responsibility: Employer handles payroll taxes
Forms: Receive W-2 forms annually

=� 1099 Contractors

Tax withholding: No taxes withheld from payments
Benefits: Handle their own health insurance and benefits
Tax responsibility: Pay their own taxes quarterly or annually
Forms: Receive 1099-NEC if paid $600+ annually

Important: Any independent contractor who you pay $600 or more to in a given year requires a 1099-NEC form for tax purposes. This form helps the IRS track payments your business makes to contractors each year.

Why Is It a Bad Idea to Pay Independent Contractors in Cash?

Because of the nuances involved with paying independent contractors, is it really a good idea to pay them in cash? While it is legal, it probably isn't the smartest business decision. Here are three major reasons why.

1. No Audit Trail

Even though it's not illegal to pay your independent contractors in cash, it might end up being more hassle for you. That's because if your company is audited by the IRS, you have to be able to prove that there wasn't a suspicious reason for paying your workforce in cash.

What the IRS Suspects

Tax avoidance: Attempting to avoid paying payroll taxes
Contractor tax evasion: Helping contractors avoid income tax responsibilities
Expense manipulation: Using cash to inaccurately report company expenses and reduce taxable income

Risk: Audits and investigations can be costly and can have dire consequences. Using a payments method with a built-in audit trail can help you avoid this.

Digital disbursements create records of all payments, which can protect your company in an investigation or audit.

2. Contractors Want to Go Cashless

Independent contractors are moving to platforms that can pay them the fastest and most reliably.

=� 80% of workers would choose one gig platform over another if it could pay them instantly without fees.Source: 2022 Gig Payments Report

Why Cash Is Inconvenient

Banking trips: You need to run to the bank to make change
Deposit delays: Contractors need to put the money in their bank to pay bills
Security concerns: Carrying and handling large amounts of cash
No instant access: Creates unnecessary delays in fund availability

Companies who don't shift their strategy won't be able to compete with employers that can send instant, digital payments. If you're wondering how to pay independent contractors in the years to come, it's digitally.

3. Proof of Income Is Harder to Verify

When you pay your independent contractors in cash, it's harder for them to keep track of and verify their total income.

When Proof of Income Is Needed

Buying or renting property
Leasing a car
Applying for loans or credit
Tax filing and documentation

Additional Burden for Contractors

Manual invoice generation: Creating their own payment records
Bank deposit tracking: Linking deposits to corresponding invoices
Documentation maintenance: Keeping detailed records for verification

Competitive disadvantage: It may be hard to attract and retain the best independent contractors when you require them to do this heavy lifting themselves.

What Are Better Alternatives to Cash Payments?

At the end of the day, you want an easy way to send quick digital payments to your contractorswithout your company or your contractors incurring any fees, tax headaches, or hassle.

� Instant Digital Payments

Immediate fund access without bank trips or deposit delays

=� Built-in Audit Trail

Automatic documentation for IRS compliance and tax purposes

=� Fee-Free Options

No cost for businesses or contractors, improving satisfaction

=� Easy Income Verification

Digital records simplify proof of income for contractors

<� Competitive Advantage

Attract top talent with modern payment capabilities

= Enhanced Security

Eliminate cash handling risks and theft concerns

At Branch, we specialize in instant payments for contractors that are free and easy for both you and your workforce. We create a seamless payment experiences for companies and contractors alike.

Frequently Asked Questions About Paying Contractors in Cash

Is paying independent contractors in cash illegal?

Paying independent contractors in cash is NOT illegal. However, it's not a recommended business practice due to audit trail issues, contractor preferences for digital payments, and income verification complications.

Why shouldn't you pay contractors in cash?

Cash payments create three major problems: no audit trail for IRS compliance, contractors prefer digital payments (80% would choose platforms with instant payments), and cash makes income verification harder for contractors.

What's the difference between paying W-2 and 1099 workers?

Unlike W-2 employees, you don't withhold taxes from 1099 contractors' payments. Contractors handle their own taxes and benefits, and require form 1099-NEC for payments over $600 annually.

What payment method is best for independent contractors?

Digital payment platforms that offer instant, fee-free payments are best. They provide audit trails, meet contractor preferences, and simplify income verification compared to cash payments.