Ill-gotten Gains

One of our more fascinating cases began with an administrative assistant at a major industrial firm being convicted of embezzling over $200,000 from her company. She had been convicted, but in exchange for early release, she had agreed to pay back half of the money she had taken (Sounds like a good deal to me!)

After she was released and in the process of paying the money back, she received notification from the IRS that the total amount of the embezzled funds would be taxed to her as income.

She thought surely she would only be taxed on the amount that she had kept but after hiring two different attorneys, she was left holding the bag for income tax on the full amount she had taken.

You see, there is a section in the Internal Revenue Code that says that money received from an illegal source will be taxed fully as earned income.

Dang those blasted ill-gotten gains!

After losing an appeal twice with the IRS, she was referred to us by another attorney friend of hers.

She tells me her story, and I’m thinking to myself, “This one may require a little extra elbow grease!”

After she finished, she asked me what I thought. I told her first thing that I couldn’t make any promises. And that we may get the exact same result as her first two tries at getting the tax thrown out.

This was gonna require some serious creative thinking.

I pondered her situation for at least an hour a day for four days straight, and then it dawned on me…

If you have, say, a construction business and you build houses, your Cost of Goods Sold is your expense for the “sticks and bricks” and labor for building the house.

Similarly, I reasoned, her “expense” of paying back the money represented her deductible cost of “doing business”…never mind that it happened to be an illegal business.

So we prepared our appeal to “adjust” the tax liability that Uncle Sam was charging for her shady activities.

Our initial appeal was rejected, just like the appeals of the previous two attorneys. So we went back to the well.

Somehow, we eventually got a decisions in our/her favor. She would only be taxed upon the funds that she kept, not the full amount that she had originally taken.

I’ll never forget the day she received a sizeable refund check from the IRS. Close to $50,000. She was ecstatic, as you might imagine.

She very graciously said she and her husband would be sending a bonus our way, which she did very soon. And she and her family continued as clients for the next 15 years.