Proper reporting of embezzled income to the IRS
To properly report embezzled income to the IRS, employers must document the losses for deduction purposes and meet filing requirements under Section 6721 and Section 6722. Reporting the embezzled income on Form 1099-MISC as non-employee compensation is necessary for each tax year affected by the embezzlement, regardless of subsequent restitution efforts.
Restitution of embezzled funds does not alter the reporting obligation. Income recognition occurs when the funds are misappropriated, unaffected by any later restitution. For instance, if a bookkeeper embezzled funds over three years and made restitution after discovery, the employer must file 1099-MISC forms for each year involved.
Failure to report the embezzled income could lead to penalties, requiring the embezzler to amend previous tax returns and potentially pay self-employment taxes on unreported income. The IRS offers options for reporting this income, depending on whether it was from self-employment activities (reported on Schedule C) or not (reported on Form 1040, Line 21).
Clear documentation by employers is crucial, as embezzlers may dispute reported amounts during legal proceedings. Providing accurate records can support the employer’s case against the embezzler and aid in tax compliance.
8 thoughts on “Proper reporting of embezzled income to the IRS”
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Is there a statute of limitations as to how far back an employer can go to file multiple year 1099-MISC’s and also amend the respective years of 1120-S’s?
Great question! In regards to the statute to file the 1099-MISC, there wouldn’t be one, since a 1099-MISC was never filed and/or issued to the employee who embezzled the funds. Statutes don’t start until the actual return is filed. On this, the company could go back indefinitely to file. You may just want to beware of any penalties the IRS may try to charge for late filing.
As far as amending the 1120-S, the IRS statute is typically 3 years from the date the return was filed. However, in this specific case, there most likely wouldn’t be a tax affect (or a decrease in taxable income) if the company were to amend its return (assume the company is cash basis). For example, if an employee embezzled $50,000 in 2010, the company’s cash balance would be lower by $50,000, presumably. Consequently, the company would have $50,000 less in net income reported on their tax return for that year. So, inherently, the company has already taken the “deduction” for the embezzlement (indirectly). Amending the returns would only inflate revenue to where it should have been and then add an embezzlement deduction for the same amount. The net taxable income effect would be zero.
If you have any other questions, be sure to contact me at msilwanowicz at shindelrock.com. 🙂
Monica Silwanowicz, CPA
Manager, ShindelRock
What happened if the embezzler is the member of LLC than how you report that in LLC return.
That is a great question but one that depends on the facts and circumstances in order to determine how best to handle. Please give us a call and we can assist in the best course of action.
Doesn’t the embezzler have a year to file an ammended return and be safe. I had someone embezzle money in 2016 and they definitely didn’t report it on their taxes. My friend said wait till next year to report it so they have no excuse and get the full charges.
Your question gets into the realm of legal strategy and we would suggest contacting a lawyer. The embezzler would be subject to the same rules as anyone else who is filing an amended return, so there isn’t really any “safe” space for them. However, the IRS isn’t overly interested in that it was embezzled money, they are more interested that it is income to the embezzler and they want the taxes related to it.
Do I have to wait until the person is convicted to file Form 1099-MISC?
It does depend if there is any doubt or the person is refuting the charge. But in general, upon discovery, the 1099 should be issued for the year(s) that it was known that the embezzlement occurred. This really depends on the facts and circumstances of the case, so it is hard to give a definite without knowing all the facts. Thanks for the question!