Determining how to record casual labour seems to be a grey area for a lot of small business owners and is often challenging. I've consolidated all the forum postings on this topic which includes how to properly pay employees with cash.
Let's begin with the most basic question asked in the forum ...
In Canada, casual labour no longer applies as a category when doing payroll except if it relates to "a purpose OTHER than your usual trade or business". If this definition does NOT apply, EI and CPP must be withheld.
You can find more information in CRA's publication Employeer's Guide - Payroll Deductions and Remittances. Search the document for the term "casual employment".
In the U.S., EDD California provided an excellent explanation on the status of casual or day laborers. As this article is from California, you will need to check your state for casual labour laws. Here is EDD's explanation:
"“Casual labor” and “day labor” are common terms used to describe workers performing a variety of services, usually on a temporary or part-time basis. Many businesses hire these types of workers and mistakenly believe that they are not employees simply because of their limited length of service or part-time hours. Even though these workers may be hired for
only an hour, day, or week, they are typically employees.
Some examples of the types of workers referred to as casual laborers include:
The link above also deals with the criteria for excluding casual labour from employment. As in Canada, one of the criteria is the service cannot be in the course of your trade or business.
For more information on IRS's position on casual labor, see Publication 15 (Circular E) Employer's Tax Guide. Go the index of the publication and look up part-time workers.
If this were me, I'd go find the day the cash wages were paid, then look for the bank deposit around that date that was shorted. In QuickBooks, I'd show the correct bank deposit (i.e. increase it by the amount of the cash wages) and show the cash wages taken at the bottom of the deposit screen. The net deposit should still match the bank statement deposit, so it shouldn't affect your bank reconciliation.
As explained earlier, casual wages require payroll deductions IF they are related to your business trade. Scott Taylor has a great article on the rules for hiring relatives and of course paying wages in cash still requires paperwork.
While income splitting with family members is acceptable, if the criteria isn't met (see "rules" link above), I'd likely book these wages as an owner's draw (sole proprietorship) / shareholder loan (incorporated) even though it means losing a tax deduction. You are still teaching your kids about working for their money.
You could create the Cash Account as a current asset if you want. Nothing wrong with that. Just remember you will have to "balance" the cash account at the end of the year so it's really just delaying your problem.
Jennifer Thieme, ezine author has an excellent article on How to Pay Employees with Cash. Just Bing/Google it to find the article.
Her method uses QuickBooks®. The bonus to you? Her method protects your business while accommodating the employee.
A short recap
Why is this necessary? It protects your business in the event of an employee dispute or a payroll audit.
I would handle the payroll run a bit differently though than the article suggests.
My choice would be to run these payroll cheques through a QuickBooks bank account type called "Payroll - Cash". This account would act as a clearing account. After each payroll disbursement, the account balance should be zero. Here's how it would work.
Step One - Do a separate payroll run for cash. Enter your payroll data as usual applying the proper payroll tax rates. This will also create pay stubs for each employee. Print out your summary payroll report.
Step Two - In your accounting software package, release the pay "cheques" issued in the employee's name. The memo field could mention that it was paid in cash. Each "cheque" would be coded to the Payroll-Cash account. Print out the pay stub for each employee.
Step Three - On or about payday, write a cheque from your regular bank account issued in your name for the exact amount of the cash payroll run (calculated in step one), ensuring the memo area of the cheque is completed and stating the payroll period. The cheque would be coded to the Payroll-Cash account. Attach the payroll report as backup.
Check Point on Account Balance - The payroll "cheques" offset the cash withdrawal from your bank. Your clearing account should now be zero if you did everything correctly.
Step Four- Prepare a pay envelope that contains each employee's cash payment AND their pay stub (which you prepared in step two).
Step Five - When you give the employee their pay envelope, have them sign for the pay either in a log (like at the post office when you pickup a registered letter/parcel) or on your copy of the pay stub. Have the employee open the envelope in front of you and count his/her pay.
Check Point on Payroll Tax Rates - I would like to emphasize that your payroll tax rates are the same as any employee paid by cheque or direct deposit. You would include and pay your payroll taxes on these cash payments in with your normal payroll source deduction remittance on form PD7A (in Canada) or forms 940 and 941 (in the U.S.) .