Reporting embezzlement to the IRS
If you’re an employer who has been the victim of embezzlement, you’re not alone. According to a survey conducted by the Association of Certified Fraud Examiners (ACFE), U.S. organizations lose approximately 7 percent of their annual revenues to fraud.
Embezzlement, or occupational fraud, can occur in many forms—from financial misstatements to fraudulent billing—and can continue for years before they’re discovered. If you’re an employer in this position, you may find yourself pondering the following questions.
- Are the embezzled funds deductible?
Yes, they are. Embezzlements are deductible as theft losses that are reported as “other expenses.” These losses are deductible in the year of discovery regardless of the year the losses were sustained. The year of discovery is defined as the year in which a reasonable person in similar circumstances would have discovered the fact of the theft loss.
- Are payments by the perpetrator considered income to the organization?
Repayments by the current or former employee are taxable in subsequent years after the year the act was uncovered. Some exceptions exist, such as a repayment plan classified as a loan with interest, whereby the payments would be a reduction of debt with the interest reported as income.
- How can the organization report these gains by the perpetrator to the IRS?
While your first thought may be to report the income on Form W-2 or Form 1099-MISC, the best option is to use Form 3949A. This is an Information Referral form for reporting potential violations of the Internal Revenue laws. The victimized organization can provide information about the embezzler such as name and address, social security number, alleged violation (i.e., unreported income), suspected amount of unreported income by year, and any additional comments. The informant may also indicate whether the books and/or records are available to substantiate the claim, the name of the bank used by the taxpayer, and if the taxpayer is presumed dangerous.
Additionally, under the Whistleblower Law, if the IRS uses this information and it results in collection of taxes, penalties, and interest in excess of $2 million, the whistleblower may be awarded 15 to 30 percent of the amount collected.