You thought you could trust your employees, but now someone has embezzled from your company. And even though you are sure you know who did it, neither you nor the police can prove it. So, you are stuck, right?

Not necessarily. You may find an unlikely ally in the IRS.

Income is income

It is a pretty safe bet that the embezzler failed to report their extra ‘income’ to Uncle Sam. And the IRS certainly will be interested in prosecuting the individual for tax evasion — regardless of whether a fraud prosecution can be mounted. Federal income tax authorities are not as concerned with the source of people’s money as with whether they paid income tax on it.

You will enjoy another benefit by getting the IRS involved: if caught, the thief will be punished and your company may be able to deduct the embezzled amount. Note, however, that you will need to report the theft to the police if you want to establish that you were a victim. Losses due to theft are deductible in the year in which they are discovered, regardless of when they occurred.

The strongest substantiation for a theft deduction is an employee’s criminal conviction. However, if your company’s embezzler has not been convicted, you may be able to use reasonable inferences that point to theft. If, for example, you discover the theft around the time your suspect employee buys a luxury car you know they cannot afford, there may be a reasonable inference that a crime has been committed.

The support you need

If you can convince tax authorities that your money was stolen and you have little chance of recovering any of it, you can deduct the full amount. But keep in mind that, if you underestimate the amount you may recover, the IRS will treat anything you actually receive over that amount as taxable income.

Before approaching the IRS about possible fraud, talk to us about the best way to enlist the government’s help. Income tax is complicated, even when it is clear you are the victim.