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FindLaw Answers Answer of the Day: Taxation of Illegal Income

Perhaps you've already responded to our suggestion to banish workplace boredom by putting your Greedy smarts to use answering the queries of FindLaw Answers users.  If not, well, just look what you could have accomplished in a few spare non-billable minutes.  Recently on the Criminal Law board, user Thevirg wanted to know why the Fifth Amendment doesn't shield him from telling the IRS about illicit income:

Congress requires, via the IRS, that you report to the IRS any income from illegal activities, such as drug dealing. If you report the income, you reveal your illegal activities. If you do not report the income and the dealing is discovered, you can be charged with income tax evasion. Does this violate the Fifth Amendment? If not, why not?
Luckily for Thevirg, Answers regular Tax_Counsel was on hand and ready to expound on crime and taxes:
It does not violate the 5th Amendment. The courts have held that you may elect to claim the 5th amendment privilege as to certain specific entries on your return if the disclosure could reasonably expose you to risk of criminal prosecution. Thus, you could describe the activities either in a general way that does not indicate illegal activity (e.g. "product sales" rather than "sales of cocaine") or, if that's not possible, you may claim a 5th amendment privilege as to the source of the income. But the amount of the income must be disclosed and the appropriate tax paid on it in order to be in compliance with the tax laws. The dollar amount of the income does not itself reveal anything criminal and thus the fifth amendment is not implicated.

Anyone in this situation is strongly urged to see a tax attorney to get this right. Making such claims in tax returns is a bit tricky and you want to do it right to get the best protection you can. In this situation, no other kind of tax professional will do because disclosure to any tax professional other than an attorney does not get the benefit of the attorney-client privilege. In other words, if you tell your CPA about your illegal drug dealing, that conversation is not protected and the prosecution can force the CPA to testify against you. The same conversation with an attorney is protected.

Note that the return disclosure rules under Internal Revenue Code section 6103 prohibit the IRS from disclosing the return to law enforcement authorities in its own initiative in almost all circumstances. Thus, if an IRS agent sees a disclosure on a return that a taxpayer was dealing drugs, he cannot simply decide to give that information to the DEA. The IRS can only give that information to DEA if the DEA makes a proper request for the return information, and to that it must already have you under investigation. In other words, the tax return would not be the thing that tips off the DEA that you were selling drugs. The rules were set up that way to encourage taxpayers to file accurate returns and pay the tax that they owe.
Now, you don't necessarily have to write several hundred words, as Tax_Counsel routinely does; wouldn't it feel good just to find an unanswered question and contribute even a short sentence or two, knowing that it could bring clarity and enlightenment to some average citizen entangled in the web of the legal system?  Or, if pro bono and the needs of others are not your thing, just think how smart you'll feel.

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