It may be a little ironic that I wrote this post on the day second quarterly tax payments are due. Do you think that might have colored the advice I gave my friends?

With all the talk of border security these days, there’s been a lot of talk about hiring undocumented workers. I’m not going to get into the moral considerations or whether or not undocumented workers “take jobs away” from legal residents—citizens or not. I’m not going into all that because by “undocumented” I mean anyone who can’t or won’t complete a W9, the form by which you would file a 1099 at the end of the year. Instead, I’m referring to what we used to call the “underground economy”—cash workers. What I will do is give you a simple formula to make your own decision.

Like all mathematical models, this one assumes some facts:

• The bids from “undocumented” contractors come in at the same price as “documented” contractors.
  This is actually the case more often than you might think. At least, the difference isn’t as big as people on either side of this issue tend to say.
• Someone pays the taxes.
  I know that’s a Big assumption, but there it is. It’s how we roll.
• We’re working on a flip.
  So all profits are taken in the same year. No depreciation, no other deferment strategies.
• The overall project is profitable.

The other day, some friends of mine were getting bids on part of a renovation. The contractor who wouldn’t provide a W9 bid $1500. The lowest priced contractor who would provide a W9 bid $1600. So, it seems like the “undocumented” worker might be a little less expensive, but is that really the case?

Here’s where the second assumption comes into play. If someone pays the taxes—either you or the contractor—who would you rather pay them? If you use the “undocumented” worker and you pay them, you need to add that cost to the bid. If you are in the top tax bracket at this time, you need to add the taxes on that $1500 to the bid.

Using round numbers, 40% of $1500 is $600 in additional taxes. That means the $1500 bid actually costs you $2100 because you’re out the money you pay to the contractor and the taxes on the $1500 profit your didn’t actually make. Even if the difference in bids had been much lower, say $1200, the actual cost would have still been higher than the “documented” contractor: $1680.

As with all other parts of this business, do the math. It’s amazing how often behaving ethically is the cost-effective way to do business.