Discussion:Reporting income from criminal activity?
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Discussion Forum Index --> Tax Questions --> Reporting income from criminal activity?
R.herkelmann (talk|edits) said: | 8 January 2009 |
| I have a client that rents rooms in his home to various persons recovering from this, that, or the other.
A current tenant of his stole (and got away with, long enough to spend) $30k in postal money orders. He was later arrested and sentenced to house arrest, and ordered to make restitution, which he has been making, in the amount of $300. per month. It seems as if this might need to be reported as income, minus restitution paid in the year it occurred, but I am at a loss as to what might be done and how it would be reported. If this IS in fact how it would work, what is the status of the restitution paid in subsequent years? Would this somehow be deductable as an expense? I can't see this as being a wash as a) the person has not YET paid the money back in full, and b) who knows if it will EVER be paid back in full, due to death, disability, or inability to find work. | |
Rgtaxservice (talk|edits) said: | 8 January 2009 |
| Shooting from the hip here - any repayment would be income (recapture) only if the stolen money was deducted as such in the first place.
If this all transpired last year then the stolen cash could on 4684 (less any repayments) and future repayments could be recaptured in future years. Too little info to go on. | |
R.herkelmann (talk|edits) said: | 8 January 2009 |
| Sorry, I was not clear enough in my original question.
I am asking if the stolen funds $30k need to be reported as income by the criminal, since the criminal spent the money already. | |
R.herkelmann (talk|edits) said: | 8 January 2009 |
| But he has not paid it back yet, other than a few thousand dollars. I find it hard to fathom that IRS would make allowances for good intentions. Again, what happens if the guy can't find work or for some other reason loses his ability to make these payments? | |
| 9 January 2009 | |
| Stolen income is included in income when received since he had use of the funds. | |
| 9 January 2009 | |
| That must be why, as a kid growing up, when I reminded my mom that she owed me $5, her response was always, "Well, I'd rather owe it to you than cheat you out of it." | |
| 9 January 2009 | |
| He gets a deduction when he pays it back. However, unless he is in the trade or business of being a thief (and he isn't), it is not a business deduction so it does not contribute to an NOL. From a tax standpoint, don't pay it back all in one year unless it's the year of receipt or you may lose much of the deduction. | |
| 9 January 2009 | |
| Well, it may be advantageous to write off the full repayment in one year if you do another big heist that will cause another big income year. But you can't do that too frequently, because if the activity is deemed to be regular and continuous, it will become a business subject to SE tax. | |
Rgtaxservice (talk|edits) said: | 9 January 2009 |
| Since he's paying it back, the amount reported in the first year would be 30K less any repayments made during the year.
He can claim future repayments as a 2% misc deduction for payments of 3K or less. If repayments are over 3K - 2% misc or 1040 line 68 (IRC1341) - with some calculations required to recapture the tax liability incurred in the original year. | |
| 9 January 2009 | |
| No deductions are allowed from illegally obtained income. Penalties and fines are not deductible, so if restitution is part of the punishment it isn't deductible. -- Larry Hess, CPA | Albuquerque, NM | |
| 9 January 2009 | |
| Rg, claim of right rules do not apply to income acquired by theft. The thief never had "an apparent unrestricted right" to the income.
I see no problem in claiming Sec. 162 expenses against the theft income (e.g. ski masks, etc). My answer would change if the criminal actvity consisted of selling illegal drugs, in which case no deductions would be allowed. | |
R.herkelmann (talk|edits) said: | 9 January 2009 |
| Thanks for the feedback!
I was pretty sure it needed to be reported, but was not sure how the repayment needed to be handled. | |
Rgtaxservice (talk|edits) said: | 10 January 2009 |
| Riley, he would still have to claim the 30K as income though - right? | |
Harry Boscoe (talk|edits) said: | 10 January 2009 |
| But why are repayments in the year of the theft allowed to offset the income directly while later years' repayments are subject to the 2% threshold on Schedule A? How are "this year's" repayments different, for tax purposes, from "next year's"?
Not challenging it, just curious. | |
| 11 January 2009 | |
| Theft income is income in the year of theft, except when repayment is made during the year of the theft. If the restitution is made during the year of the theft, then the Tax Court says, “…….where a taxpayer mistakenly obtains funds to which he is not entitled and in the same year recognizes a fixed and definite obligation to repay and makes provision for such repayment, the amounts received are not to be considered as taxable income in the year of receipt.” Mais v. Commissioner. | |
Rgtaxservice (talk|edits) said: | 11 January 2009 |
| How it that stolen money returned in the year of theft can be used to reduce the taxable 'theft income', but any repayment in subsequent years cannot if the right of claims rules do not apply to theft income? | |
Harry Boscoe (talk|edits) said: | 11 January 2009 |
| RileyII, what you've quoted here seems to relieve "a mistaken obtainer" of being taxed on "mistakenly obtained" funds - completely - if in the year he stole it he acknowledges a duty to repay it and arranges to pay it all back. That's how "and in the same year recognizes a fixed and definite obligation to repay and makes provision for such repayment" reads to me.
Is this from the du Mais or Mais case? Where can I find it? | |
| 11 January 2009 | |
| Income from illegal activities is taxable. Remember Al Capone? He went to jail for tax evasion. | |
| 12 January 2009 | |
| "He gets a deduction when he pays it back" Deduction for what?
It was illegal gain which was taxable to begin with so how is it deductible at all??? Did he really declare it as income and pay taxes on it? If not, he still has to amend the return and show it as income for the year he stole it. taxea | |
| 12 January 2009 | |
| Yes, he does have to declare it as income. But once reported as income, he still gets a deduction for the payback. It doesn't have to be "claim of right", just a repayment of an amount previously included in income. | |
| 12 January 2009 | |
| The Mais court went on to say that the amount of taxable income recognized in the year of theft should be reduced by the amount repaid in the year of the theft. See 51 TC 494. This is a 1968 case. | |
| 7 February 2009 | |
| I still don't understand why the thief gets a deduction when he pays it back. He didn't have a right to it in the first place so wouldn't this be like a personal loan and repayment of personal loans are not deductible. taxea | |
| 7 February 2009 | |
| Taxea - I believe the above discussion is assuming that the money was declared on a tax return when obtained. R.herkelmann has read about Al capone and the problem of not reporting ill got gains. | |
RoyDaleOne (talk|edits) said: | 7 February 2009 |
| Where a law serves a remedial and punitive purposes, a determination must be made as to the purpose for which the payments were made. S & B Restaurant, Inc. v. Commissioner, 73 T.C. 1226 (1980). In Mason & Dixon Lines, Inc. v. Commissioner, 708 F.2d 1043 (6th Cir. 1983), a trucker paid penalties for violating the maximum weight and size rules under a state statute that imposed both fines and liquidated damages. Because, the statutory rule under which the payments were made was determined to be compensatory in nature, rather than punitive, the payments were determined to be in lieu of liquidated damages and, deductible.
Because fines are considered "paid to a government". If they are paid to an injured party, pursuant to the direction or supervision of a government agency, restitution payments paid to victims are considered non-deductible fines or penalties under Code Section 162(f) provided they are paid in lieu of other penalties or fines (e.g., prison term reduced for payment of restitution). Where restitution payments are ordered in addition to other punishment, the outcome is less certain. In Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990), the court determined that an embezzler's restitution payments were primarily a remedial measure to compensate the victim and thus deductible. The Second Circuit based its decision on (1) the trial court judge's concern over making sure the victim got back the embezzled funds, and (2) the fact that the taxpayer was required to serve a prison term and pay a fine in addition to making restitution payments. The determination is made on a case-by-case basis. | |
| 7 February 2009 | |
| if the client claimed the income on a tax return prior to the year of the embezzelment it is not income to be claimed again.
If the crook claimed the income...which I doubt...it was ill gotten gain from which he should not benefit. It would still liken to a personal loan of which the repaid principal and interest would not be deductible by the crook. | |
| 7 February 2009 | |
| Roy, thanks for your analysis. However, I repeat my concern that restitution paid in lieu of additional jail time may not really be compensatory in most Circuits. | |
RoyDaleOne (talk|edits) said: | 7 February 2009 |
| I agree Riley, and included a caveat (last sentence) trying to allude that a determination, may be impossible or difficult to determine, and it would be the taxpayer responsible to "prove" the correctness of such a determination. I just wanted to post what I considered the correct line of inquiry for a tax practitioner to follow. | |
| February 8, 2009 | |
| Roy, did you mean to post your analysis under the other discussion, how to report embezzled income? It seems like it fits better there. | |
RoyDaleOne (talk|edits) said: | 8 February 2009 |
| Natalie, yes it fits better there, however, the question of:
"If this IS in fact how it would work, what is the status of the restitution paid in subsequent years? Would this somehow be deductable as an expense?" was in the original post. I was reading this post, and I have canned analysis for certain situations, this one is for fines, penalties, and court ordered restitution payments. | |
