Why Paying Cash Doesnt Pay
“I’ll complete your work for $1,000 or if you pay cash, $700.” We ‘ve all heard this phrase before, or some variation on it, many times. Real estate investors often hear such proposals when seeking quotes for repairs on a property. We’ll then get the question, “What should I do?”
Let ‘s be clear, the “friendly repairman/woman” is looking to commit tax fraud. Period. We could have a philosophical debate as to whether we should support this, but let’s delve a little deeper first.
First, to ensure that there is a clear understanding, I believe that it is completely wrong to commit tax fraud and stealing by accepting any cash job. Accepting cash for work/materials when you legitimately declare the income is totally acceptable. Similarly, paying someone in cash in and of itself is totally legal (making certain assumptions regarding what is being purchased, for example). Anyone who is dealing with tax fraud could contact lawyers at Brotman Law or other firms to assist and offer guidance to employers through the confusing process that comes with improper tax payments.
But, what are we to say when presented with price differentials between cash and receipted work. You could ask the repair person:
· Are you willing to commit tax fraud?
· Ever heard of “Thou shalt not steal?”
· How much is lost in tax revenue in the country, potentially resulting in some combination of underfunded schools, health care, excess interest costs funding deficits, and [insert your favorite purpose here]? Yes, our governments waste money but aren’t those who are law abiding still saddled with subsidizing tax fraudsters?
· How can I protect myself from problem work if there is a warranty issue when I cannot demonstrate that I purchased your services/materials?
However, my expectation is that if someone is willing to commit tax fraud, moral arguments will serve little purpose.
So, what’s in it for you?
First, you are required to prepare your financial statements and tax returns to the best of your ability. This can include estimates for expenses. However, this doesn’t naturally equate to Revenue Canada blindly accepting some “napkin calculations” because you ‘re a nice person. Yes, reasonable estimates are accepted in certain cases. However, it can prove to be quite a challenge to convince the CRA that they should allow a deduction when you cannot produce a receipt. Yes, perhaps they can see a cash withdrawal from your account. But, what’s to say that the funds didn’t get spent on some other non-deductible expense? Now you’re risking missing a tax deduction, and to add insult to injury, you also risk having the CRA claim that you personally received the money and should be taxed on the same. Ouch!
Is the price differential on “paying cash” ever in either party’s best financial interest?
Typically, in the “pay cash scenario” the theory is that the repair person would have to pay too much tax to complete the work. In theory, the cost savings to the purchaser you would be greater.
Let’s examine this more closely.
Purchaser: If you pay cash for a service, you are possibly going to lose a deduction of up to approximately 45%, assuming that you are either in a higher tax bracket or corporately investing in rental income. So, in our $1,000 expense example, you may, when audited, be found to not just have a $450 tax savings thrown out, but even “better”, you could have an additional $450 of taxes payable on the personal side as a result if you are using a corporation. That’s $900 “lost” in the worst case scenario. Oops.
Over the table: $1,000 @ 45% tax savings = $450 deduction (Net cost of job: $550)
Under the table: $700 net cost of job (plus tax risks)
Service Person: Assuming that they receive the income as a small business owner who earns taxable income of less than $500,000 per year (likely the case for someone offering such a proposal) and they earned their income through a corporation (if they don’t have a corporation, perhaps they should?), they would pay tax at roughly 15%, depending on their province of residence.
So, to be clear, if someone is really saying that they are willing to commit tax fraud, it’s likely because they’re not willing to pay 15% tax, or $150, in our example.
Over the table: $1,000 @ 15% tax rate = $150 in tax = $850 for the job take home
Under the table: $700 for the job take home
Going back to our original example, you were better off paying the $1,000 and getting the receipt as your net cost would be approximately $550. The service person was going to get more than their asking price after taxes if they were properly set up from a tax perspective ($1,000 less taxes of 15% netting $850 vs. their offer of $700 in our example). If the price spread was less, you’d be better off potentially even paying them more than the asking price just to do things legally.
What about GST/HST?
The service person will be indifferent to GST/HST as it is money in and out. You may be indifferent financially, or worst case, receive a deduction and some additional cost. The difference is too small to impact our conclusion, despite what I perceive are frequent exaggerated claims as to this difference.
In the end, both parties in this example would have been better off financially doing things the “right” way, leaving aside the moral aspects.
Simply put, this is just one more example of why crime doesn ‘t pay.
George E. Dube, CPA, CA is a veteran real estate investor and accountant. He has spoken, written various articles, and co-authored two books on real estate accounting. Reach George at: gdube@bdo.ca or @georgeEdube.
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