Tags: illegal | income | IRS | tax

IRS: Report Your Illegal Income

Monday, 04 Mar 2013 09:03 AM

By Michael Kling

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When you file your taxes this year, don’t forget to declare your illegal income.

That’s the message from the IRS.

If you’re wondering, put it down on Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040) if it’s from your self-employment.

Editor's Note: The IRS’ Worst Nightmare — How to Pay Zero Taxes

Some criminals — but not many — actually do declare their illegal income. Typically, they’ve been caught or think they’re about to be caught in their illegal activity, San Francisco tax attorney Stephen Moskowitz told CNNMoney. They hope to avoid being charged for tax evasion in addition to being charged with the original illegal activity.

Many of those claiming the income face embezzlement charges.

Tom Hughes, a New England accountant, paid taxes in 1999, 2001 and 2004 on money he embezzled from clients, CNNMoney reports.

“I knew the money was taxable, there was no doubt about that,” Hughes told CNNMoney. “I had already been caught, and I didn’t want to face federal tax charges.”

Hughes, who served nine months in prison, says he’s reformed and works as an anti-fraud consultant, running his business Hire-a-thief.

The IRS declined to say how many crooks pay taxes.

It’s not clear if the IRS tells law enforcement agencies about illegal activities, but by law, it’s not supposed to offer the information to other agencies, unless it involves terrorism. And even then it needs a court order to divulge the information.

However, the rules are complex and have exceptions.

Tax experts told CNNMoney they believe the IRS does indeed share the information. The IRS was mum on the issue.

The good news for crooks is that if they pay taxes, any restitution later paid to victims is tax deductable.

Questions about what is legal and what should be taxed can be complex.

The IRS says sellers of controlled substances, including marijuana grown for medical purposes, cannot deduct any ordinary business expenses other than the cost of the goods they are selling, writes Benjamin Leff, a tax professor at American University Washington College of Law, for Slate.

That hasn’t been an issue before, but 18 states and the District of Columbia have now decriminalized or legalized marijuana for some purposes.

“State-licensed marijuana sellers must pay federal taxes not only on their profits but also on the money they spend on salaries, rent, advertising and all the other expenses,” Leff says.

To avoid the tax, marijuana sellers should seek to qualify as nonprofit “social welfare organization,” he advised.

Editor's Note: The IRS’ Worst Nightmare — How to Pay Zero Taxes

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