Reporting illegal income: compliance can help avoid tax evasion charges

Do you really have to report illegal income to the IRS? Yes, it’s counter-intuitive. But the answer is yes.

Of course, compliance with this requirement is not common. But some taxpayers do choose to report income from illegal activities. As we will explain in this post, one reason for doing so is to avoid facing federal tax evasion charges.

In its Publication 17, the IRS uses income from illegal drug sales as an example of illegal income. Publication 17 also mentions receipt of a bribe.

Perhaps an even better example is embezzlement. If you have been charged with embezzlement or believe you may be charged, that is already a serious situation. But you could face additional charges for federal tax evasion if you don’t report the income from the embezzlement. And if you are an accountant, you may very well be aware of the requirement to report illegal income.

Can the IRS tell other agencies – particularly law enforcement agencies – about a report of illegal income? Generally, the law prohibits such disclosures, except in terrorism cases. The rules on the confidentiality of tax returns are pretty complicated, however, and it is possible for law enforcement agencies to seek a court order to get access to them.

There may also be a gap between theory and practice on the disclosure of illegal income reports. In other words, the IRS may share the information with law enforcement even when it’s not supposed to.

If you are unsure about whether or how to report illegal income, you should discuss your circumstances with a tax attorney who handles criminal cases.