Academic journal article Journal of Accountancy

Accounting for Sticky Fingers

Academic journal article Journal of Accountancy

Accounting for Sticky Fingers

Article excerpt

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. …

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