Embezzler's Tax Return

[Jill Graff]

I am trying to determine the tax implications for an embezzler. (We don't need to discuss my taking on this client. She is a long-time client who wants to make restitution and get this all behind her.)

Situation: Employee is in mediation because she embezzled $200,000 from 1998 thru 2006 from her employer (Company) by putting personal items on the business credit card and Company paid them (and deducted them as business expenses). Company has offered to take 4 pieces of property Employee owns in settlement and not take the incident to court.
Employee's basis in properties - $800,000
FMV of properties - $2,000,000

Question 1: Is the transference of the property treated as a sale on Employee's tax return? a. If it is a sale, is the gain FMV less Basis ($2M less $800k),
b. or a loss of $800k less $200k (Basis of property given up for debt)?

Question 2: I believe the $200k embezzled becomes taxable income. Do I amended 1998 thru 2006 tax returns or just 2006 (the year the embezzlement was discovered)?

Eveything I have researched discusses the situation from the standpoint of the person who had the bezzlement happen to them, not from the standpoint of the perpetrator.

Needless to say, thank-you in advance for any thoughts on the matter. (And yes I have covered my self with engagement letters, etc.)

[taxea]

Embezzler's Tax Return

My thoughts:
If there is no criminal filing and the employer agrees to take restitution for the original loss, I would treat the amount as a loan from the employer. The payment of the loan would be the property the client agreed to give to the employer as restitution.
There is no loss to the client. To me the difference between basis and debt could be treated as non-deductible interest paid on the loan. This would not be a sale, it would be a payment of loan debt. The amount would not be "income" if treated as a loan from the employer. I certainly would put all the details in a written document that is signed by both parties.
I don't know how this would fly with the IRS. It's just a thought and I would certainly research it with the IRS before proceeding. It's a matter of: is an embezzlement if restitution is agreed upon and no criminal filing is done?taxea

[erchess]

My Reactions

Question 2- I am sure that you have to amend the returns for the years in which the crimes took place if you have to amend at all. Income, after all, is reported in the year it is constructively received. My question would be whether you can get by with putting it on 1040 L 21 or you must put it on Sch C and SE. My other question would be whether she has to amend at all given that she will be making restitution.

Question 1- I don't have enough information. Will she be returning four items she embezelled or four other items or what? On the other hand, since when is making restitution a taxable or deductible event?

I realize that if I'm right (tax plus se plus penalty and interest going back a long way on the funds she embezelled, and no sort of tax benefit for making restitution) is correct, she may owe more than she can pay. That would raise the possibility of an OIC. Any doubt you could raise as to whether she really owed that much would help the OIC also.

[taxea]

If my information is acceptable to the IRS...there is no need for amended returns because there was no "income" there was a loan. Loans are not taxable they are repaid. The payment is not deductible because it would be consider a personal loan and the difference between the employee's basis and the total "reimbursement" would be non deductible interest from a personal loan. taxea

[erchess]

I like Tax EA's treatment

and I would suggest that the contract between her and the company specify that it was a loan and that it is being paid back with interest or that the interest is being forgiven, in which case she may realize taxable income in 08.

I realize that from the point of view of the taxpayer's current pain, the easy thing to do would be to ignore the whole deal for tax purposes. I am afraid that this course leaves her open to much worse pain later when the IRS starts to make arguments that the situation should have been reported in some way. I am fairly certain that the IRS will go along with a contract that specifies that there was a loan and market rate interest. It's similar to the situation most of us have experienced as children - do you want to accept the punishment proposed by the teacher that will be the end of the matter or do you want to take your chances on an interview with the principal?

[JoshinNC]

That's one hell of an interest rate

I am trying to determine the tax implications for an embezzler. (We don't need to discuss my taking on this client. She is a long-time client who wants to make restitution and get this all behind her.)

Situation: Employee is in mediation because she embezzled $200,000 from 1998 thru 2006 from her employer (Company) by putting personal items on the business credit card and Company paid them (and deducted them as business expenses). Company has offered to take 4 pieces of property Employee owns in settlement and not take the incident to court.
Employee's basis in properties - $800,000
FMV of properties - $2,000,000

Question 1: Is the transference of the property treated as a sale on Employee's tax return? a. If it is a sale, is the gain FMV less Basis ($2M less $800k),
b. or a loss of $800k less $200k (Basis of property given up for debt)?

Question 2: I believe the $200k embezzled becomes taxable income. Do I amended 1998 thru 2006 tax returns or just 2006 (the year the embezzlement was discovered)?

Eveything I have researched discusses the situation from the standpoint of the person who had the bezzlement happen to them, not from the standpoint of the perpetrator.

Needless to say, thank-you in advance for any thoughts on the matter. (And yes I have covered my self with engagement letters, etc.)

Unless you made a typo, the client embezzled $200,000 and is giving the company assets worth $2,000,000. I wish someone would steal from me and give me that kind of payment in return.

[thomtax]

Unless you made a typo, the client embezzled $200,000 and is giving the company assets worth $2,000,000. I wish someone would steal from me and give me that kind of payment in return.

Heck, I wish I had $200,000 to embezzle. If they took $200, I would notice it. :-)

Reminds me of the local church secretary that embezzled $65,000 from the church. It was not caught by the church, but by a new employee at the bank that did not know how to handle something. When she asked about it, someone began looking closer. The church had never missed the money.

My first thought was that a church that had so much money that it can be missing that much money without notice, things are not being used as they should be. Of course, as usual, I reserve the right to be proven wrong.

LT

[bullroot]

Considerations if embezzlement is treated as a "loan"

As suggested by taxea treating the embezzlement as a "loan" that is being paid back with interest seems to be a reasonable solution to this dilemma. However, here are a few considerations that I think are important.

For the employers to demand $2,000,000 worth of property with a fair market value for the repayment of a "loan" of $200,000 with interest which was likely received in increments over a 8 year period would likely involve usury.

Remember, the employers is going to have to pay taxes on the Interest on the loan and if the amount being repaid is more than the taxpayer's basis in the property, the employee is going to have to pay taxes on the amount being paid less the basis in the property.

Assuming the embezzlement was treated as a loan of $25,000 per year for eight years the repayment of the principal with interest at 20 perccent would be inside $800,000, the employee's basis in the four properties. The employer would have a tax obligation on the $1,800,000 of interest received. ($2,00,000,000 - $200,000)

To minimize potential problems going forward, the employer should not demand restitution for the "loan(s)" and interest that would impose interest rates in excess of the usury rate and should accept property with a fair market value in line with that as restitution.

If this were done, the employee would owe taxes on the amount of the restitution less the basis in the property given up as restitution and the employer would owe taxes on the interest on the "loan" .

IRS gets taxes on the interest from the employer.
IRS gets taxes on any ltcg on the property transferred from the employee to the employer
The problem is resolved with minimum pain for the employee and the employer with no repercussions going forward assuming IRS buys-in to the resolution.

At least that is the way that I see it.

[Snaggletooth]

Gravel in the Shoe

Two gravels in the shoe - rather questions. I don't know the answer, but they are both relevant.

1) The effect of not bringing this to court means there is no crime. Your client has "lost" $600,000 based on her original cost, not counting market value. If this is no crime, then what kind of transaction is it? A sale? If so, why is there no loss? I could be missing a written forbearance, if indeed one will exist. If so, does this mean the forbearance is valued at $600,000? If we go down that road, the "real" forbearance is valued at $1.8MM. A written forbearance probably brings crime back into the definition - but I'm no lawyer.

2) Treatment of the $200,000 as a "loan" brings up the spectre of interest, as discussed. However, I'm not sure that there is a requirement to impute interest if the parties are not related taxpayers. This will have an impact to the employer because if interest is imputed, it will reduce his basis. His basis, even without interest, is only $200,000 for property worth $2MM.

From the outset, Jill didn't want us to invade the character issue, or whether she should be dealing with the client. Respecting that wish, I won't go there, but I've got to wonder if the exchange of $2MM for $200,000 is a negotiation for more than just embezzlement. Jill is not being told everything.

[snowbird]

This could be come a criminal matter quickly. Suggest you send her to an attorney. Even if you are a Cir 230 tax preparer (CPA or EA) your discussions in a criminal matter are not privileged (only an attorney). If you are not a Cir 230 ... discussions are not privileged period.

[bullroot]

OOPs ! An Issue that we have overlooked

As Jill Graff indicated in the original post, the employer unwittingly reported the losses from embezzlement as business expenses since the employee charged personal items to the company credit card. To get straight with IRS, the company is going to have to correct that if the embezzlement is treated as a loan. Otherwise, from a theoretical standpoint, the "tax basis" in the property of $200,000 would be wiped out.

What a mess!

[myerstaxes]

Here is an article from the AICPA

about this very issue, hope it helps you...

Accounting for Sticky Fingers

In the crime of embezzlement, there are tax implications for both the embezzler and the embezzled.

Embezzled income is taxable to the person who does the embezzling (revenue ruling 61-185, 1961-2 CB 9; revenue ruling 65-254, 1965-2 CB 50; James v. United States, 366 US 213 (1961), Ct. D. 1863). The embezzled amount should be included in the embezzler's gross income in the year of the embezzlement. In addition, the embezzler/employee may be subject to self-employment taxes on the embezzled amount.

Since the embezzlement constitutes income to the embezzler, the entity that has suffered the loss should report it to the IRS.

Proper reporting of the embezzled income to the IRS will provide the employer with documentation for deducting its loss and also meet the filing requirements of section 6721 and section 6722. It will, in addition, alert the IRS to possible unreported income by the employee.

The employer should report the embezzled income on form 1099-MISC as non-employee-compensation. The employer must prepare a form 1099-MISC for each tax year the employee embezzled funds.

Restoration of embezzled funds does not affect the reporting requirement. Income is recognized at the time the embezzler takes control of the funds (Ernestine K. Alcorn, TC Memo 1969-751), and, is, therefore, not affected by subsequent restitution. Thus the embezzler would be required to report the restitution as a miscellaneous itemized deduction subject to the two-percent adjusted gross income exclusion in the year of the restitution.

The following example shows how embezzled income should be reported for tax purposes.

An organization's bookkeeper embezzled funds for three calendar years beginning in 1996. The company dismissed the employee in 1998 when it discovered his theft. At that time, the organization decided to prosecute, and the employee made a $5,000 payment in restitution. The amounts embezzled were $5,000 in 1996, $30,000 in 1997, and $10,000 in 1998.

The company must file 1099-MISC forms with the IRS for the tax years 1996 through 1998.

In 1998, the embezzler would have an additional $10,000 in gross income but could include the $5,000 restitution payment as a miscellaneous itemized deduction. As the $10,000 may be subject to self-employment taxes as well as income taxes, the $5,000 payment would be the only reduction of the embezzler's increased taxable income.

The embezzler would also be subject to penalties if the additional income for the 1996 and 1997 tax years was not reported. The embezzler would have to file amended returns for those two years, and the income might be subject to self-employment taxes.

The IRS offers the embezzler two options for reporting the increased income. If the embezzled funds are from self-employment activity, schedule C or schedule C-EZ should be used and the amount is subject to self-employment taxes. If not, the embezzled funds can be reported on line 21 of form 1040 and are not subject to self-employment taxes.

Observation: Taxpayers who embezzle funds over several tax periods are subject to a variety of income taxes and penalties. Companies that have been embezzled are subject to additional reporting requirements.

If the amounts embezzled cannot be absolutely determined, it is the responsibility of the embezzler to prove to the IRS that the amounts reported by his or her employer to the IRS are not correct. Such evidence could benefit an employer during legal proceedings against the embezzler.

—P. Michael McLain, CPA, DBA, associate professor of accounting, and Marc I. Lebow, CPA, PhD, associate professor of accounting, Hampton University, Hampton, Virginia.

[Jill Graff]

Embezzler's Problem

Thanks to everyone for jumping in. The information has provided some guidance, but I am still at a loss how to determine how much restitution has been paid? Would it be the amount stolen-$200k, the basis in the properties to be used for restitution-$800k, or the FMV of the properties-$2m?

Thank-you for your insight!

[ChEAr$]

A MOST interesting discussion

But first, as one reply at length put it, and if asked, IRS would agree, the 200,000 is income,.
properly attributed to each year. Amended returns are called for; however since this was
a regular employee (as opposed to subcontractor), line 21 is appropriate and no SE tax.

Another suggested going to an attorney; GOOD advice. Sounds to me like employer is
holding all the aces and in effect blackmailing the employee, i.e. we won't report the crime if you'll pay us ten times value. I just wonder what a judge would think of this! That's why
an attorney should be engaged ASAP. He can probably work out a deal without losing the whole 2 millions dollars AND keep employee out of jail. Of course I'm not condoning the crime, but condemning the employer for being greedy.