Proper reporting of embezzled income to the IRS

Proper reporting of the embezzled income to the IRS provides employers with documentation for deducting losses and meeting 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  099-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, 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.

Consider this example:

An organization’s bookkeeper embezzled funds for three calendar years beginning in 2010. The company dismissed the employee in 2012 when it discovered his theft. At that time, the organization decided to prosecute, and the employee made a $5,000 payment in restitution. The amounts embezzled were $5,000 in 2010, $30,000 in 2011, and $10,000 in 2012.

The company  must file  1099-MISC forms with the  IRS for the tax years  2010 through  2012.

In 2012, the embezzler would have an additional  $10,000  in gross income but could include the $5,000  restitution payment as a miscellaneous itemized deduction. As the $10,000 may be subject to self-employment taxes as well as income taxes, the $5,000 payment would be the only reduction of the embezzler’s increased taxable income.

The embezzler would also be subject to penalties if the additional income for the 1996 and 1997 tax years was not reported. The embezzler would have to file amended returns for those two years, and the income might be subject to self-employment taxes.

The IRS offers the embezzler two options for reporting the increased income. If the embezzled funds are from self-employment activity, schedule C or schedule C-EZ should be used and the amount is subject to self-employment taxes. If not, the embezzled funds can be reported on line 21 of form 1040 and are not subject to self-employment taxes.

Taxpayers who embezzle funds over several tax periods are subject to a variety of income taxes and penalties. Companies that have been embezzled are subject to additional reporting requirements.

If the amounts embezzled cannot be absolutely determined, it is the responsibility of the embezzler to prove to the IRS that the amounts reported by his or her employer to the IRS are not correct. Such evidence could benefit an employer during legal proceedings against the embezzler.

Reference:
http://www.journalofaccountancy.com/issues/1999/aug/accountingforstickyfingers.html

 

8 thoughts on “Proper reporting of embezzled income to the IRS”

  1. T Paul Anderson says:

    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?

  2. 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

  3. khalid Latif says:

    What happened if the embezzler is the member of LLC than how you report that in LLC return.

    1. Steve Wisinski CPA CFE MAFF says:

      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.

  4. steve fox says:

    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.

    1. Steve Wisinski CPA CFE MAFF says:

      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.

  5. Stephanie Adams says:

    Do I have to wait until the person is convicted to file Form 1099-MISC?

    1. Steve Wisinski CPA CFE MAFF says:

      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!

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