Cold, hard cash can be very hard to trace. This makes accounting for cash wages in Income Replacement Benefit (IRB) calculations tricky.
There are any number of instances when a person might be paid in cash: tips for waiting tables, housekeeping, contractors, whether employed or self-employed, and often when working for family members.
So, how do we prove an insured earned a particular wage when they were paid in cash?
As with most income, cash wages should be considered when calculating an IRB, however, the following must be considered:
- Is there reasonable evidence of receipt of cash for services rendered?
- Has the income been reported for tax?
Starting at the Tax Return
Pursuant to s.4(5) of the Statutory Accident Benefits Schedule (SABS) if an insured has not reported the cash as income on their tax return, it is not considered in calculating the Insured’s pre-accident income for IRB purposes.
So all you need to do is report the cash for tax?
No, it isn’t that easy. There are times, especially with family businesses, in which you need to ensure the income reported for tax purposes is fair market value in relation to the work completed.
To further complicate the issue, there is a delay in reporting income for taxes. For example, an employed individual does not have to prepare a tax return for a particular year’s income until April 30 of the following year. This means, if the accident occurs in July, for example, it would take almost a year to confirm if the insured has reported this cash income for tax.
This leads us to our next issue. How do we quantify something the insured may not have tracked? There is no one way, and it is definitely determined on a case-by-case basis, but the following will give you some general guidance.
Quantifying Cash Income – Where to begin
As forensic accountants, we play a role in assessing the existence and quantum of cash income an insured may have received. This will obviously vary on a case-by-case basis. However, it is important to recognize that in some cases there might not be a perfect solution. It’s cash after all!
Ascertaining a precise calculation in an income situation where cash wages are involved can often be impossible. As such, the test is often reasonability for an IRB calculation. Is it reasonable the insured:
- Earned the indicated level of wages
- During the time period indicated
- Performing the job indicated
How do we Test Reasonability?
Step 1 – Gather background information
Understanding the insured’s employment situation is an important piece of this puzzle. Common questions we ask, include:
- Is the insured related to the employer (see related Family blog)?
- What were the average hours worked by the insured each week?
- What tasks did the insured performed?
- How was the level of pay determined?
- What are industry averages?
Step 2 – Request supporting documentation
There will not always be documentation available, or at least not obvious documentation. So you may need to look for documentation that supports the reasonability of the insured’s claim, as opposed to the specific receipt of income.
- Historic tax returns to compare reported income year-to-year.
- Signed receipts from the employer, prepared prior to the accident not retroactively.
- Documents to support the earnings and work availability for other employees at the same employer, or to support the wages paid to the insured’s replacement. There will be privacy issues, so don’t expect to receive names with this request.
- The insured’s bank statements may provide a means to match the timing of any deposits with the story provided by the insured. However, cash rarely all hits a bank account, and so draw conclusions from this source cautiously.
Step 3 – Assess Reasonability
As we have previously stated, it is unlikely the documentation you receive will validate the insured’s receipt of cash income with absolute certainty. So, you now need to assess its reasonability.
- Compare documents from different periods to look for consistency.
- Compare the reported income with industry statistics, including specific geographic regions, industries, and age brackets.
- Request information from third parties, such as industry associations or other employers in the same industry.
- Review the individual’s lifestyle for assessing reasonability, although this can be much more difficult to assess without the insured’s cooperation.
There are limited FSCO / LAT decisions that address cash income directly. However, there have been a number which address an insured’s lack of documentation and how to support an insured’s income in those situations.
Without getting into specifics, here are some as a starting point:
- Li Pan and Allstate Insurance (FSCO A16-003705), which allowed the IRB calculation to be based on the limited documentation available and discusses the importance of credibility.
- Qureshi and State Farm Mutual (FSCO A14-066819), which states, “However, after reviewing the Schedule, I cannot find any provision that suggests exactly what evidence an Insurer has to have to establish employment and income.”
- Mills and Canadian General (FSCO P-005599), which states, “The goal should be finding a reasonable basis for making the calculation, not punishing poor record keepers.”
Red Flags to Keep Watch For
All the steps you have taken thus far, were to assess reasonability. Red flags exist to help identify something which isn’t as you would expect or doesn’t appear reasonable. It’s important to remember though, that an unlikely occurrence isn’t an impossible occurrence.
While the examples below are by no means exhaustive, they do provide a starting point for your investigation.
- Variance from industry statistics – a waitress working in a small town is unlikely to earn $300 in tips on a Tuesday evening, although that same waitress working during a film festival in a major metropolis can easily earn over $300 in tips on the same evening.
- Inconsistency with historic tax returns or income reported on other sources. An example is Employment Insurance benefits being received while the insured claims to have been working.
- Bank statements show varying levels of deposits month to month, but the income level reported remained the same.
- An employer who will not sign off or confirm an employee’s wages.
- An insured having started a job right before the accident or claiming an income level very close to the policy limit.
In these instances, the claim should be investigated further to rule out any concerns.
What this means for you
If an insured claims to have received cash wages which have not previously been reported on an income tax return, it is essential to assess the reasonability of the insured having received the income claimed.
Follow the steps above, and always keep your eyes open for situations that don’t seem reasonable in the circumstance. There will always be outliers, situations that fall outside the norm, but that may just be an indicator that additional investigation is required.
As always, the team at ADS Forensics would be pleased to talk with you further if you have questions, whether general or about a specific claim. You can reach us at firstname.lastname@example.org or 1-800-380-7908 ext ASK (275).