California readers may be surprised to learn that not only does the IRS ask taxpayers to list any illegal income they earn on their tax return, but some actually do. The IRS instructions for tax returns state how illegal income should be included on the tax forms. It should come as no surprise that most criminals do not declare their ill-gotten gains, but those who do have specific reasons for doing so.
Those who decide to include illegal income on their tax returns usually do it because they believe that their criminal activities are currently being investigated or they have already been caught. If they declare their illegal income, it may help them avoid getting into further trouble from tax evasion down the road. Additionally, if taxes are paid on illegal income and the person is required later to pay restitution for his or her crimes, the restitution can be deducted on taxes. According to one attorney, many individuals who choose to declare their illegal income have been charged with embezzlement.
While it is the law to declare all income, including any obtained illegally, it can also be tricky when the income is not documented. If the taxpayer is audited, he or she has no paper trail to show for that income. In situations like this, the IRS expects the taxpayer to provide contact details for others who may have been involved in the criminal activity. However, the IRS legally cannot alert law enforcement unless the criminal activity involves terrorism.
Most taxpayers in California and elsewhere have no reason to be concerned about this issue. However, others may do well to seek guidance as they work on their tax return for the IRS. In any situation, filing a complete tax return that includes all income may help everyone avoid additional stress and headaches if their returns are called into question later on.
Source: CNN Money, "The IRS wants to tax your illegal income," Steve Hargreaves, Mar. 1, 2013