It is not illegal for employers to pay employees in cash, reports About.com, although this practice can get business owners in trouble with the government over tax evasion. Employers also risk running afoul of worker's compensation laws. To avoid legal troubles, employers must keep detailed records of all cash payments to workers.
About.com notes that employers are required to pay all payroll taxes when paying cash to workers. This includes Social Security and Medicare. Business owners caught avoiding payroll taxes can be prosecuted if they falsify tax forms. For instance, Knoxvillebiz.com wrote about one business owner who pleaded guilty to misrepresenting wage information on his tax form to avoid payroll taxes. Under-reporting wage income is a crime that carries stiff fines and may include jail time as well.
Employers may also get into legal hot water if a cash-only worker's actions trigger an audit, About.com warns. For example, a problem arises if a worker who is "not on the books" becomes injured on the job and seeks medical attention. When the worker reveals to doctors that the injury is work related, officials are bound to discover the employer's failure to pay into worker's compensation. Similarly, a worker who files for unemployment or disability benefits after working "off the books" is likely to trigger an audit of the employer.