Disguised Wages: What You Need to Know!

Someone asked in one of my videos:

A popular luxury watch dealer has been paying his employees by way of paying for the rent for their beach front apartment, and other things like leasing a Corvette for the videographer to use. Is this legal? Can you comment on that from a tax point of view?

It's a very interesting question. I’ll discuss the ramifications of what are called disguised wages, and what you can do if you’re the victim of a disguised wages scheme. 

So the issue here is what the IRS refers to as “disguised compensation” or “disguised wages”. Here’s what they have to say about this:

In tax law, "disguised wages" refer to payments made to a worker or contractor that are intended to appear as something other than standard income, with the purpose of reducing or avoiding income or payroll tax liabilities.

Basically, if you have an employee, or independent contractor providing services to your company, you typically pay them for those services. Which is their compensation for the services provided.

Normally, the business can deduct the payment on their taxes. The business would also provide the employee a W-2, or for an independent contractor, a 1099-NEC. These tax forms provided to the employee direct them to pick up the income on their personal tax return.

From a tax perspective, the practice of disguising wages can lead to serious problems. Let’s break it all down

Payroll Taxes

So what’s the harm in working around the rules and paying employee expenses directly like for the rent expense for an expensive beach front apartment?

Well, on the surface it may not seem like a big deal, but it’s essentially tax evasion.

By doing this, the business is avoiding employment taxes, which is 15.3%, and if you think about it, robbing the employee of their share of the employment taxes. Which is Social Security and Medicare at 7.65%.

The employee is also likely avoiding personal income taxes, because it’s doubtful they are reporting the disguised wages as income on their tax return, since they’re probably not receiving tax forms to report the income. Think about it.

The average income tax rate is 24%, so there’s also that.

Employees are also robbed of unemployment compensation benefits, and workers compensation if they get hurt on the job. The employee may also not be protected by Federal employment laws.

In this example of paying an employees rent and paying for their leased Corvette. I don’t know if they are or they aren’t, but the employer should be reporting these payments as compensation to the employee.

If you run the numbers on $50,000 for example, then that’s $7,650 in employment taxes that’s been avoided, and $12,000 in personal income taxes, on the employee side.

It adds up, and it would also be subject to heavy fines, penalties and interest. And keep in mind, the IRS is very strict when it comes to employment taxes. If you look at their budget, employment taxes is largely what funds their operations. They view employment taxes as like a trust fund. Employers are basically custodians for withholding and remitting employment taxes to the IRS. The taxes are to be collected and remitted to the IRS in a timely fashion.

To not remit employment taxes to the IRS is a big no no. They pursue this aggressively and can even go after people individually, if they can determine they are a responsible party.

Audits and Scrutiny

If someone is caught trying to pull a fast one by disguising their wages, they might land themselves in a whole lot of trouble. You see, the IRS could decide to take a really close look at everything else they've got going on, financially speaking. It's like inviting an IRS agent into your home - they'll comb through everything, to see if things add up. It's not just about the wages anymore, it could end up being about their entire financial life.

In the example of the employer paying an employees beach front rent for an apartment, and corvette lease payments. These aren’t even allowable business deductions from what I can tell.

So think about it. Personal rent and lease payments on a personally used car, these are not eligible business expenses, so no business deduction would be allowed. The employer can’t deduct these on the business side.

When people or businesses hide their real wages, it's not fair to other businesses who play by the rules. It’s also not fair to the employee whose getting robbed of the benefits mentioned, previously.

But it's also important to remember that not everything that looks like "hiding wages" is bad or against the rules. Sometimes, businesses change how they pay people to lower their taxes, but they do it in a way that's legal and follows IRS rules. They usually get help from professionals who know a lot about tax laws in order to do this.

Even though hiding wages might seem like a good idea to save money in the short run, it can cause a lot of problems later on. It's generally not a good idea and can be pretty risky.

So the big news this year was with former president Donald J. Trump and his long time CFO, Allen Weisselberg. They had a very similar decades long - disguised wages tax avoidance scheme. Weisselberg admitted in court that he should have paid taxes on off-the-books compensation, totaling roughly $200,000 in one year, which included a luxury Manhattan apartment overlooking the Hudson River, and two Mercedes Benz car leases among other things.

Does this sound familiar? Weisselberg could have served up to 15 years in prison, but he made a deal with the Feds to testify truthfully against the Trump organization, which reduced his sentence to 5 months in Rikers prison, but he still had to pay 2 million dollars in back taxes and penalties to the IRS.

To wrap things up, if you feel that your employer is not doing things properly, maybe they’re paying you as a 1099 independent contractor, when in fact you believe your classification should be as an employee.

You can fill out an IRS form SS-8. It’s a way to request from the IRS to intervene and determine the status of a worker for purposes of federal employment taxes and income tax withholding.

Filing a Form SS-8 requesting a “worker status” determination means you are asking the IRS to establish if the services you provide to the company are those of an employee or an independent contractor.

As an employee, this form can help you in preserving your rights and benefits.

Thanks for reading, and see you in the next blog post!