Today the vast majority of peoples’ incomes is easily traceable in the form of checks, bank accounts, business records of wages and dividends paid, etc. But back in the days when much or most income was received in cash, how could the IRS/US Treasury know what your income was? Sure they could take the trouble to audit suspicious people (e.g., Al Capone) but they couldn’t research every income-earning citizen in the US. If William F. Smith of Boise Idaho claimed he made so much money the previous year as a self-employed handyman, how could anyone prove differently?
Pre or Post form W2?
I don’t know how far back you’re talking but but in the pre-electronic days, employers just mailed in their copy of the W-2’s. As a small business, I still do that myself since it’s actually easier than doing it electronically (at least for the State part).
As for self employed people that get paid in cash, that’s a whole nother story. Even now it’s mostly impossible for handy man types that work in cash and don’t give out receipts. If you have some guy come fix your water heater and hand him $100 and he doesn’t give you a receipt, he’s not reporting it either. Next time you’re working with a handyman and he says ‘do you need a receipt’, (if you don’t) say ‘can I get a discount if I don’t need one’. You’d be surprised how often you can get a few bucks knocked off for saying that. If he says ‘no’, then make sure you get one. That’s the tradeoff, he pockets the money and saves 30%, you should get 10% off. If he doesn’t offer a discount for the ‘no receipt’ option, then he can report the income and you get the benefits that come with having a receipt.
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Most people who don’t make a lot of money don’t pay a lot of federal tax. It’s not worth the risk of lying about it; conversely, it’s not worth investigating. People who should be reporting six figures or more and don’t generally are the ones who get audited. Those people did not ever get paid primarily in cash.
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Paychecks aren’t the only way to track money disbursed. A company that paid in cash would keep books and be able to verify how much it paid.
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It’s not that hard (for the IRS) to investigate someone and find out about how much money they make. If the handyman reports $20,000 it can easily be compared to his mortgage, other bills, and luxury goods to see if that’s plausible.
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The Social Security Act was passed in 1935, just nineteen years after the Sixteenth Amendment established the constitutionality of the federal income tax. The time between “the existence of the income tax” and “the time when nearly every employer needs to track and report wages anyway” was short.
When were w2 forms created? When I search for it i just get a bunch of stuff about how to find your previous W2s, which isn’t what I want to know.
The 16th amendment was passed in 1913 (though there were earlier income taxes). How were taxes determined in the early part of the 20th century? It would have been technically possible to do something very close to the modern method of employers sending the government a w2 or similar form, but I don’t know in practice what was done.
I have no data on this, but it’s entirely possible that in 1913, and for many years afterwards, only a small proportion of the workforce earned enough to have any liability for federal income tax. According to Wikipedia, when the federal income tax was introduced in 1913, there was no liability at all on incomes under $3,000 which, in 1913, must have meant the great bulk of the workforce was excluded. I don’t know when income tax became an issue of relevance to someone on the average wage.
Really? He can save that much by not reporting the income?
There’s no 30% tax bracket, so strictly speaking, probably not. The 28% tax bracket kicks in if you earn at least $89,351 (and that’s after your standard deduction and personal exemption which together total $10,150). So the guy fixing your water heater would have to be making almost $100,000 of reported income for him to save 28% by not giving you a receipt (well, to be fair, some states have income tax. So last year Illinois had a 5% income tax, plus if you were in the 25% tax bracket, which starts at $36,901 taxable income, yeah, in Illinois he could easily save 30% by taking cash and not reporting it to the IRS)
There is if you include payroll taxes. If you’re self-employed, you have to pay both halves of your Social Security and Medicare taxes too (15.3%).
Ooh, good point. It always seemed so stupid that they “split” the social security and medicare into “employee” and “employer” halves. Any economist will tell you that it doesn’t matter which side of the transaction is taxed. I guess the worker doesn’t see how much he’s being taxed if you do that (same thing I just did)
Just a minor point: If you have two or more employers in a given year and your Social Security wages go over the cap in that year, you can get a refund of taxes withheld over the cap, but your employers cannot.
It does to the person paying the tax. And to the employer, for that matter.
In 1943 the IRS started requiring employers to withhold income tax (oddly enough, it was already a requirement for SS taxes.) At that point it would have been necessary to have a form telling both the taxpayer and the IRS how much tax had already been paid, so they would know whether the employee still owed money or was due a refund.
Exactly, the guy earning minimum wage, just like the plumber, would probably prefer not to have to pay the employer share himself. Changing that would require raising the minimum wage, but the guy making over minimum wage would then not be guaranteed a raise.
OTOH, if SS is like the Canadian CPP, you only pay on the first $X of income (about $45,000 this year). So unless the handyman claims a fairly low level of income, they won’t save SS deductions.
In the U.S. the cap on Social Security is $118,500, so there’s considerable room under that to hide income.
I’m not sure I buy that. If the laws were changed so I was paying the full SS tax and my employer wasn’t paying any, and I didn’t get a raise to make the change neutral, I’d raise exactly as much hell as if my employer cut my pay by that much.
Which is to say, if there are employers that could get away with the pay-cut-via-ss-tax-change method, why wouldn’t they just cut their employees pay right now?
They needed the higher pay during good times to attract employees. not sure how it works in the USA, but if you cut pay rate (i.e. $/hr) in Canada then generally you have to offer the option of separation pay.
No, it doesn’t. Both come out with the same net amount no matter which one officially pays it.
FWIW, the case against Capone had to be more involved then a mere “audit” suggests. He had no bank accounts and didn’t own anything in his name. The case was based on a combination of a)raids on gambling operations he owned (which produced ledgers of profits), b) the testimony of associates identifying him as the proprietor of these establishments, c) the testimony of sales people identifying Capone as a prolific spender (perhaps his biggest downfall - he loved to spend lavishly on all manner of luxury items, and he was memorable for paying largely in cash and being generous to the workers he dealt with), and d) Capone’s own admission of income (a misguided decision by his lawyers to try to negotiate a settlement).
Here(warning: PDF) is a fascinating report by the IRS detailing the case against him.
I’m sure it depends on the state and the industry and what someone’s contract might say, but I don’t believe there are general restrictions like that in the US.
In many states, you don’t even need a reason to fire someone.