It’s Fix the Tax Code Friday!
One of the “ask the taxgirl” posts this week focused on the question of illegally gained income. According to the Tax Code, all income, regardless of the source, must be reported on your tax return. This includes drug sales, illegal betting operations, prostitution, bribes, the whole bit.
Clearly, including this income on your return, while required, opens you up to additional scrutiny from additional authorities. The tax return could serve as a “road map” to your illegal activities.
Should the IRS share this info? Should it be “off limits” to other authorities?
Today’s Fix the Tax Code Friday question is:
Should the IRS be prohibited from sharing tax information related to illegal activities – under any circumstances, including subpoena – in order to encourage tax compliance? And if so, are there any crimes that you would suggest could be opted out of such a ban?
Well, it might result in more taxes being collected — not a lot, I think, but some. Given the way the Federal government has behaved in the past several years, most people wouldn’t believe their information is confidential, even if the law says so. I don’t have any illegal income to hide, but when I make out my tax returns I assume that almost anyone who wants to can look at them one way or another, even though there are supposed to be safeguards against such. Yeah, right!
All in all, I say leave things as they are; at any rate if we can get something about unreported income on them we always can get them for tax evasion. That’s the only way they were able to put Al Capone in jail.
I think the taxation of illegal income is intended more as a anti-crime provision than an anti-tax-fraud provision. That is, I think the government is more interested in jailing criminals than taxing them. That said, once they’re in jail, Uncle Sam will be glad to impose some tax, but the jailing is the main thing. Prohibiting the IRS from sharing info just to increase tax compliance is letting the tail wag the dog here.
I think Silent Cal had it right, at first. The idea behind it is to be an anti-crime doorstep rather than a way to keep people from committing tax fraud and bring in revenue. I think it’s designed around being a starting point for investigations, Al Capone being the classic example. At best, this change would bring in a small amount of revenue. It would probably just be used as a foundation for people to argue the legitimacy of illegal acts since they are paying into the system the same as legal means of making income.
The Code does not need to be fixed. Taxgirl, I assume you are aware of section 6103. This section prevents the IRS from disclosing return information except pursuant to the narrow exceptions contained therein. While this section permits the IRS to disclose return information to state and local tax authorities, it does not appear to permit the disclosure to local criminal enforcement agencies. On the other hand, the IRS is authorized to disclose return information to federal agencies for criminal non-tax purposes but only pursuant to a court order requested by certain enumerated high government officials. Thus, the Code already prevents the IRS from just sharing return information with other federal or local government agencies and the restrictions are substantial in regard to disclosure to other federal agencies for non-tax purposes. By enacting section 6103, Congress ensured that taxpayers would feel secure that their return information would be adequately safeguarded, thus encouraging voluntary compliance with the Code. Indeed, IRS employees may not even disclose return information to other IRS employees unless those employees can show they have a need to know. Moreover, as you point out, the Code requires taxpayers to report all income, from whatever source, whether illegal or not. The legality of the income being reported is irrelevant for tax compliance purposes. If a taxpayer reports all his income, even if it is illegal, and pays it timely, he is in compliance with the Code. Al Capone was not jailed because he sold booze illegally under state or federal laws, but because he fraudulently failed to report all his income. The principal purpose of the Code is to raise revenue, subject to various policy objectives interjected by Congress. The most effective mechanism to accomplish this is by taxpayers voluntarily complying with their obligations under the Code. Congress inserted the penalty and criminal provisions in the Code to enforce taxpayers’ voluntary compliance. Criminal prosecutions by the IRS are therefore a means to ensure that taxpayers voluntarily file their returns and report all their income. Also, as I recall, the Form 1040 and its attachments, do not require taxpayers to identify the source of their income (unless you are a wage earner) but to report the total amount of the income.
If some enforcement agency wants the information from your tax return all they have to do is petition some judge to sign an order. Just exactly how hard do you think that would be? And some District Attorney (or the judge) can make more points on how tough he (or she) is on crime on their road to the next step in their political ambitions.