In most cases, cash income is taxable under the requirements of the U.S. Tax Code. Failing to report it may be considered a crime. Those who do so run a risk of being audited, charged civil penalties or even criminal prosecution.
Cash income, by its very nature, is very difficult to track. Many times, those paying cash for employee salaries are doing so because they also have something to hide. Usually, it is in the best interest of a business to keep meticulous records concerning employee payroll. Business paying cash may be doing so to make it easier to continue certain business practices such as employing illegal immigrants or paying less than minimum wage. Still, it should be noted that not all companies paying cash for salaries are doing so because they desire to be unscrupulous.
If the U.S. Internal Revenue Service feels that cash income is not being reported accurately, the agency will likely initiate an audit. Due to the fact many of the documents and financial statements normally available to auditors are not normally available when dealing with cash, the audit is likely to be more difficult and extensive, both for the agency and the individual being audited.
In some ways, this is a good reason for someone receiving a large portion of cash income to make sure he or she is reporting it accurately. To discover unreported income, the IRS may look at a number of different things. First, auditors will likely look at bank statements. If deposits exceed reported income for the year in question, an explanation will be required. Second, the auditor may look at expenses and determine if there are substantially more expenses, per year, than reported income. If so, that could also require some explaining.
The IRS is also known to frequently audit those who are self-employed and those who work in jobs known to receive a substantial amount of cash income, such as food servers and taxi cab drivers. This is because these occupations have more of a temptation to underreport income because there are fewer checks and balances. For people in these occupations who strive to report their income accurately, they should keep good records of their cash income.
While most cash income is taxable, it is important to note that not all cash payments made may be subject to taxes. Reimbursements made for business and travel expenses, for example, are not subject to taxation. For those unsure if a certain income is taxable, it is best to consult a tax advisor.