The courts classify illicit income as gross income. They interpret the broad definition of gross income in paragraph 61(a), which includes “all income from any source,” as including ill-gotten income.1 Stolen funds are therefore considered part of the recipient`s gross income and must be reported in the year in which the funds are withdrawn. This represents a kind of catch-22 for buyers. If the tax-conscious criminal reports income, the discrepancy between his or her legal income and the amount of income he or she reports can alert law enforcement to possible illegal gains. Conversely, the decision not to declare the profit illegal is punishable by a tax penalty. Thus, a criminal who refuses to declare his illegal income may face a tax penalty in addition to imprisonment, a fine and civil liability for his crime. Section 280E of the Internal Revenue Code expressly denies the deduction or credit for expenses in a business consisting of trafficking in illicit drugs “prohibited by federal law or the law of any state in which such trade or business is conducted.” [15] Penalties for participation in an illicit income scheme vary depending on the type of offence involved and the applicable laws related to the commission of that offence. This means that someone who has chosen to participate in an illegal poker game can be fined, while someone who has embezzled funds from an employer faces not only fines, but also jail time. Similarly, an investor convicted of the crime of insider trading, when this type of activity is prohibited by law, may also face imprisonment, as well as fines and restrictions on continued participation in investment markets. In James v. United States (1961),[4] the Supreme Court held that a wrongdoer was required to include his ill-gotten profits in his “gross income” for federal income tax purposes.
In making this decision, the Court considered the landmark case in which the definition of gross income was set out in the tax legislation, Commissioner of Internal Revenue v. Glenshaw Glass Co.[5], in which the Supreme Court held that a taxpayer has gross income if he or she has “access to assets that are clearly realized and over which taxpayers have full control.” [6] At the time the perpetrator acquired the funds, he had no consensual repayment obligation or restrictions on the disposition of the funds. [7] If he had acquired the funds in the same legal circumstances, there would have been no question of whether he should have had gross income. Therefore, embezzlement had gross income within the meaning of the Tax Code, even though the application of another body of law would later require him to return the money. While embezzlement, thieves and others are forced to report their illegally earned income for tax purposes, they can also deduct costs related to criminal activities. For example, Commissioner v. Tellier, a taxpayer, was convicted of carrying on commercial activities contrary to the Securities Act of 1933. [8] The taxpayer then deducted the legal fees he had incurred in his defence. [8] The United States The Supreme Court ruled that the taxpayer could deduct attorney`s fees from his or her gross income because they met the requirements of section 162(a),[9] which allows the taxpayer to deduct all “ordinary and necessary expenses paid or incurred in the taxation year in the course of carrying on a trade, business or business.” [10] The Court held (and the Internal Revenue Service did not dispute this point) that it is customary and necessary for a person working in a business to expect legal fees related to that business, even if such things can only happen once in his or her life. [9] As a result, the taxpayer for Tellier was allowed to deduct his lawyer`s fees from his gross income, even though he had incurred the fees for his crime. The United States In Tellier, the Supreme Court reiterated that the purpose of tax legislation is to tax net income, not to punish illegal conduct.
[11] The court suggested that Congress amend the tax code to include specific tax rules for illegal conduct if it fails to do so. [12] This note argues that the current policy of classifying ill-gotten funds as gross income challenges fundamental notions of fairness and justice. Taxing illegal income as gross income is a penalty for purchasers. This unjustified sanction is fundamentally unfair and serves no legitimate aim. Since a victim`s right to recover stolen funds is often contingent on the service`s tax claim against the buyer, taxing illicit income undermines victims` chances of recovering the withdrawn funds. Given these undesirable consequences, the federal government should consider abolishing the use of fiscal sovereignty and at least subordinating the government`s claim to that of the victim. It`s hard to document illegal income, Moskowitz says. At the end of the year, put away drawers and empty wallets with receipts, remember to report to the IRS any income you earned from drug transactions, bribes, stolen property, prostitution, or other illegal activities. The result would be the same if the taxpayer filed tax returns and did not report the income, as they would have an unlimited period to file refund claims, given previous fraudulent tax returns.
The taxpayer could theoretically file amended tax returns at any time to correct previous returns. The taxpayer would have to disclose the fraud for the IRS to process late refund claims, which would likely result in the review of amended tax returns. But the taxpayer would still have the opportunity to present the idea that the income was actually a tax-free loan that was repaid. Legally, this is not possible unless a law enforcement agency receives a court order giving them access to an individual taxpayer`s tax return. The IRS should not proactively warn other agencies of wrongdoing, except in the case of terrorism. In this case, it still takes a court order to disclose something, but the IRS can initiate the legal process itself. No. There you have it: www.irs.gov/publications/p17. Do a “search” search with your browser and enter the word “illegal”.
Then enter “stolen”. You will find the entries under “Other income”, which are worded exactly as follows. Humorous, as they appear on their faces, the statutes have the force of law and have been in books for years. Prohibition-era gangster Al Capone was charged with tax evasion after prosecutors claimed his reported income didn`t match his lavish lifestyle. Yes, you read that right. Illicit drug trafficking? I have to pay taxes on this income. Stealing property? I have to report that as income. “The IRS would certainly report it immediately to law enforcement,” said Joseph Henchman, vice president of legal and government projects at the Tax Foundation, a think tank.
“Congress requires you to bring in all your income — legitimate or not,” said David Cay Johnston, an investigative journalist who specializes in tax law issues. “There are people who file taxes and list criminal activity like `prostitutes` as their profession.” But some do, often if they`ve been caught in that tax year or think they`re going to be caught, says Stephen Moskowitz, a San Francisco tax attorney at Moskowitz LLP who has helped several clients document their illicit profits. Their goal is to avoid being charged twice: once for their original crime and once for tax evasion on their manna. After all, it was tax burdens that ultimately took Al Capone. According to the courts, an employee who misappropriates funds cannot have an “unlimited right” to income because he or she cannot believe that he or she has a limited right to income. This makes sense in a case of embezzlement, as the employee is acting outside the scope of his or her professional duties and the proceeds are preserved in the prosecution of the offence. In Wood v. The Commissioner remained faithful to the precedent when he found misappropriated funds that were taxable to the defendant. It is generally accepted that proceeds of embezzlement and other illegal activities are taxable to those who receive such illicit funds. Despite the fact that Wood, the buyer, funneled some of the embezzled funds into his business instead of using them for personal expenses, his initial control over the funds established his personal tax liability. While the court made the appropriate decision, Wood`s finding highlights a troubling practice of taxing illicit income, effectively penalizing purchasers who receive an additional penalty, and diminishing victims` hopes of recovering stolen funds.
Part II of this note provides an overview of the historical development of the case law on gross income tax. Part III examines the gross tax classification of diverted income and other types of illicit income.