Anyone who is consciously involved in criminal activities such as buying stolen goods, selling drugs or laundering money knows the obvious risks. The police can arrest you, the prosecutor can charge you with a crime, and the court (if they find you guilty) can impose hefty fines or even send you to jail. These are the inherent dangers. However, did you know that failure to report income from these illegal activities can lead to the Internal Revenue Service imposing a large tax bill against you? 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.»  Following the assessment, the credit rating agency normally assesses the taxpayer`s illegal income for tax payable. In addition, the CRA regularly applies penalties for gross negligence, which usually represent 50% of the tax owing. Under section 238 of the Income Tax Act (the «Act»), any person who fails to file a return or otherwise comply with the Act will be liable on summary conviction to a fine of $1,000 to $25,000. Under article 239 of the Act, anyone who evades or attempts to evade tax is liable to a fine of 50 to 200 per cent of the tax to be evaded. Failure to comply with the law can also result in imprisonment for up to 24 months. In addition, daily interest also applies to taxes and penalties owing. After the assessment, and if the taxpayer does not exercise their appeal rights, the CRA may proceed with collection activities, including garnishment of wages, seizure of bank accounts, property, etc. Wait a minute, how can the IRS tax income to which the taxpayer had no legal right? The Internal Revenue Code explicitly defines «gross income» as «any income from any source.» 26 U.S.C. §61(a).
The U.S. Supreme Court has ruled that gross income exists when there are «instances of indisputable access to wealth that are clearly realized and over which taxpayers have full control.» Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431; 75 p. ct. 473; 99 L. Ed. 483 (1955). «All sources» include those that are both legal and illegal. In practice, Moskowitz says he believes information about illegal activities is being shared. People convicted or likely to be convicted of embezzlement will report their income to avoid prosecution for tax evasion, Stephen Moskowitz, a San Francisco tax lawyer, told NBC News.
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 IRS does not require reporting details beyond an approximate amount you earn. The hardest part comes when you`re audited. There is usually no paper trail, so IRS agents typically ask for the names and contact information of people who may have been part of the illegal transaction, Moskowitz says. The agency will then try to verify your numbers with them. 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. In James v. United States (1961), the Supreme Court ruled that embezzlement was necessary to include his ill-gotten profits in his «gross income» for federal income tax purposes. In making this decision, the Court took into account 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., in which the Supreme Court ruled 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.»  At the time the perpetrator acquired the funds, he had no consensual repayment obligation or restrictions on the disposition of the funds.  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. In 2019, the IRS added a question on forms asking taxpayers to indicate whether they were involved in cryptocurrency transactions. In 2020, the IRS moved it to the top of Form 1040. Last year, the agency said it seized $3.5 billion in cryptocurrency assets. As ridiculous as it may seem, the federal government requires that illegally acquired money be reported and taxed in the same way as legitimate income. It`s right there on the IRS`s official tax instructions: «Income from illegal activities, such as money from illegal drug trafficking, must be included in your income on Form 1040, Line 21, or Schedule C or Schedule C-EZ (Form 1040) if you are from self-employment.» If you decide to disclose your illegal loot, make sure you do so with the help of a tax lawyer, not an old accountant. The «claim» allows a tax deduction for the current year for amounts that are refunded in a subsequent year for certain amounts that a taxpayer included in the income of a previous year and that was taxable in a previous year. A person who derives income from the sale of a Schedule I substance may claim a tax deduction on the cost of goods sold, but no other tax deductions.
  Unlike other commercial activities, tax deductions are not permitted for ordinary and necessary business expenses such as rent, utilities and advertising.  The first step is to file an objection setting out the reasons why the credit rating agency`s tax invoice is incorrect. At this stage, a CRA appeals officer will review submissions on business expenses and actual revenues from the illicit business. And, of course, if a taxpayer fails at the notice of objection stage, they have the right to appeal to the Tax Court of Canada, the Federal Court of Appeal and, with leave, the Supreme Court of Canada.