Tax consequences of embezzlement and subsequent refund

A neighbor was just indicted for embezzlement. Here are the facts assumed from newspaper articles:

2004: embezzle $145,000 but does not declare it on the tax return 2005: embezzle another $245,000, but does not declare it on his tax return.

August, 2008: He is arrested for embezzlement. The entire $390,000 is refunded in an effort to mitigate the criminal charges.

The IRS has been notified. OK, he "under reported" his income in 2004 and 2005, but what happens (tax wise) in 2008 when his total income is only $130,000?

And just out of curiosity, what would happen if he HAD declared the embezzlement on his 2004 & 2005 tax return?

Reply to
NadCixelsyd
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Rarely a safe assumption, but...

Assuming he's a cash-basis taxpayer (almost every individual is) he filed false returns for 2004 and 2005. IRS will be chatting with him about this from the civil side. (I'm assuming he has a good enough lawyer that the criminal aspects of the 2004 and 2005 returns are already being dealt with.)

He may be able to generate a deduction or credit for the year of repayment. See IRS Publication 525.

Well, he wouldn't have any IRS problems on top of his other legal problems. He'd probably also make the cover of Time magazine as the only person on record to do so. Come to think of it, he probably should anyway since he hadn't yet frittered away the money and had it to repay the victim when he got caught.

Reply to
Phil Marti

The answer is complicated. See the linked court opinion.

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Condor

Reply to
Condor

As always, "It depends."

Better known as when bad things happen to corrupt people.

Dick

Reply to
Dick Adams

In this case, he's NOT entitled to a claim-of-right deduction because he's being CRIMINALLY prosecuted. The courts have generally ruled that an embezzler can use the CoR method only when civilly sued by the victim without prosecution. (I did this research in the early 1990's when I still worked at the IRS and was auditing an embezzler).

Authority: IRC 162(f). Repayment in a criminal case is often part of the fine or penalty.

I concur. No tax due as it's already paid.

Reply to
D. Stussy

I suspected that might be the case, which is why I hedged and said "may" be eligible in the original response. Thanks.

It was so much easier when they finally got to Collection. If there was anything left after Vegas or wild women, the lawyers already had it.

Reply to
Phil Marti

My favorite court case dealing with this issue is Yerkie v. Commissioner, circa 1976. I wanted to refer the original poster to the Yerkie case but couldn't find a public Internet link to it.

Condor

Reply to
Condor

He will be taxed on his income in 2004 and 2005. For 2008, when he's sitting in jail making no money, he'll get a deduction for $390,000.

No refunds for 2004 or 2005. He'd still get the deduction in 2008, at least to the extent he paid it back.

Stu

Reply to
Stuart Bronstein

No, he won't - for the reason already posted. No deduction in 2008.

Reply to
D. Stussy

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