Crime May Not Pay. But...

Internal Revenue Code Section 61 might be the single most important provision of the entire law. It provides that “Gross income means all income from whatever source defined.” It then goes on to include 14 specific sources in that overall definition, including 61(a)(2): “Gross income derived from business.” (Because you’ll ask, “gross income” doesn’t include the change you find in your couch cushions; however, it does include the change you find in your friend’s couch cushions.)

Of course, taxing businesses on gross income before expenses would make no sense. It takes money to make money. Thus, Section 162 steps in to provide deductions for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” So far, so good.

But—what if the “trade or business” in question is . . . sketchy? What if it’s outright illegal? Is the income still taxable? Are the expenses still deductible? You might be surprised at how much time and effort the IRS and various courts have invested in answering those questions. (The answers probably came as an unwelcome surprise to Al Capone, who wound up finding himself in Alcatraz. Fun fact: he played banjo in the prison band, the Rock Islanders.)

This week’s story takes us to Saratoga, California, where Jonathon Chang became an elder at the Home of Christ 4 Church and assumed responsibility for managing donations. Three years later, he set up a nonprofit to support the church and a for-profit LLC to manage rental properties. Then, he found a rich donor who gave $6.75 million to build a new building and support missionary work. Did Chang show appreciation by quickly deploying the money for the church? No! He thought, cha-ching! and sent $6.7 million to his own accounts.

In Mario Puzo’s Godfather, consigliere Tom Hagen muses, “There are things that have to be done and you do them and you never talk about them. You don’t try to justify them. They can’t be justified. You just do them. Then you forget it.” Sadly for Chang, Uncle Sam doesn’t forget so easily, and Chang wound up on trial for wire fraud, conspiracy to commit wire fraud, money laundering, and conspiracy to commit money laundering. Naturally, Chang hired a lawyer to defend him. Said lawyer cost $365,735—which Chang deducted on his Schedule C. The jury wound up convicting him on seven counts. But then, adding insult to injury, the IRS shot down his deduction for legal fees, and Chang found himself fighting the law again—this time in Tax Court.

Last month, Judge Peter Panuthos ruled that the claim arose in connection with Chang’s pursuit of for-profit activities. He then affirmed that “public policy does not prohibit the deduction of legal fees relating to criminal activity so long as the legal fees are an ordinary and necessary expense of a trade or business.” And voila, Chang had his deduction back.

Deducting legal fees probably won’t bring Chang much comfort. He’s already been to prison, and he’s still under supervised release. He’s forfeited his interest in five rental properties worth $8,841,749, and he owes another $11,701,262 in restitution. He’s 68 years old, and not likely to spend his golden years living his former high life.

I realize you have no intention of asking us to deduct illegal expenses on your tax return. But this week’s story is yet another reminder that the tax code is full of expenses you don’t know you can write off. That’s where we come in, scouring your finances to find them and put them to work for you. Call us to see how much you can save!