Legal Question in Tax Law in New Jersey

Re: Income Tax on Restitution Funds

The proceeds of the theft are deemed to be income in the years of receipt under the "claim of right" doctrine. If those years are still "open" (either under the statute of limitations-3years normally, 7 years if there is deemed to be a fraud in the originally filed return- or under an extension that the taxpayer has consented to)then the taxpayer will have to file amended tax returns for those open years. If the years are "closed" (more than 3 or 7 years, as applicable)the taxpayer will NOT have to recognize the proceeds of the theft and pay taxes on that money.

In the years in which the repayments are made, the taxpayer may be allowed a deduction but the amount of the deduction will be a complex calculation, most likely under the rules of the "tax benefit rules" of the internal revenue code. If the amount of money is significant, you will need help from an experienced tax attorney or CPA.

Remember, the IRS will always negotiate if you are properly prepared; don't just roll over for them.

Good luck.

If you have additional questions, I can be reached at [email protected]

Re: Income Tax on Restitution Funds

Income tax is levied on income "from whatever source derived" and case law is clear that proceeds of criminal activities are included. Even if a court subsequently orders restitution, it is highly unlikely that the funds would be repaid during the same tax year. Thus, the taxpayer in question is likely to have a timing issue. He should ask a CPA for assistance in preparing an amended return for the year in which income was received, and ascertain whether the return of the funds in a subsequent year entitles him to any kind of deduction (sorry, I don't know this off-hand).

Best wishes,

LDWG