Ever wondered how the IRS views income from illegal activities? Believe it or not, the IRS doesn’t care if your business is legal or not—they still expect their cut. And in some cases, even expenses tied to illegal activities can qualify for deductions! While you (hopefully) run a legitimate business, this story will give you a fascinating glimpse into how bizarre tax laws can get—and how you could be leaving money on the table without knowing it.
The IRS has built a complex tax system, and for savvy business owners, that complexity can work in your favor. Even though you won't need to deduct criminal defense fees like some people in these wild cases, there are hundreds of legal deductions you're probably not taking advantage of. This is where experts like Anvil Tax come in—we uncover every possible tax-saving strategy for you.
The Law That Makes It All Happen: IRS Code Section 61
The cornerstone of the U.S. tax system is Internal Revenue Code Section 61, which declares: “Gross income means all income from whatever source derived.” It doesn’t matter whether it’s a paycheck, a side hustle, or even profits from something illegal—if you earn it, it’s taxable. The section lists 14 specific sources of income, including “gross income derived from business.”
But here's where things get tricky—taxing gross income before deducting expenses wouldn’t be fair. That's where Section 162 kicks in, allowing businesses to deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” So, legal or not, businesses have the right to claim expenses, within certain limits.
What Happens When Your Business Crosses Legal Lines?
Now, let’s talk about the gray areas—what happens if your “business” isn’t exactly legitimate? Are the profits still taxable? Are the expenses still deductible? Surprisingly, the IRS and courts have spent years deciding the answers. (Hint: Al Capone, the notorious mobster, found out the hard way. He was sent to Alcatraz for tax evasion, even though he ran an empire of illegal enterprises. Fun fact: he played banjo in the prison band, the Rock Islanders!)
But it gets crazier. Even if your business dealings are shady, you might still be able to deduct certain expenses. Let’s explore a modern example that will blow your mind.
The Shocking Case of Jonathon Chang: Church Donations Gone Wrong
This week’s story brings us to Saratoga, California, where Jonathon Chang served as an elder at the Home of Christ 4 Church. His role included managing church donations, but rather than fulfilling his duties, Chang used his position to siphon money into his own accounts. A generous donor gifted the church $6.75 million to build a new facility and support missionary work, but instead of fulfilling the donor’s wishes, Chang pocketed $6.7 million.
If you think that’s bad, it gets worse. Chang set up a nonprofit organization and a for-profit LLC, presumably to manage real estate. But once the cash hit his accounts, he decided to redirect it for personal gain.
Much like a plot out of a crime thriller, Chang soon found himself in legal trouble. Facing charges of wire fraud, money laundering, and conspiracy, Chang turned to a legal defense team, racking up $365,735 in legal fees. And here’s where the IRS story takes a wild twist: Chang tried to deduct those legal fees on his tax return!
Can You Really Deduct Legal Fees for Criminal Activity?
Yes, you read that right. Jonathon Chang claimed his legal fees as a business expense, deducting them on his Schedule C. And although the IRS initially denied his deduction, he took his case to Tax Court. Here’s what happened: the judge ruled that legal fees can be deductible, even in criminal cases, as long as they are considered “ordinary and necessary” for the business.
Judge Peter Panuthos ruled that because Chang’s legal fees were tied to his business, they qualified as an ordinary expense. In short, public policy doesn’t automatically bar criminals from deducting legal fees—but only if those fees are related to a business activity.
Though Chang managed to keep his deduction, it was little comfort. He had already served prison time, forfeited five rental properties worth over $8.8 million, and still owed over $11.7 million in restitution. At 68, his golden years look far from bright.
What’s the Lesson Here for You?
While you're (hopefully) not trying to deduct legal fees for illegal activities, the takeaway is this: the tax code is filled with deductions and nuances that can save you money—if you know how to find them. Whether it’s related to business expenses, real estate ventures, or maximizing personal deductions, these rules can be complex, but they can work in your favor.
How Anvil Tax Can Help You Maximize Your Deductions
At Anvil Tax, we specialize in uncovering every possible deduction to ensure you never pay more than you owe. Whether you’re a realtor, a small business owner, or just need expert tax advice, our deep understanding of the tax code allows us to craft strategies that save you money and protect your wealth.
The IRS may not care where your income comes from, but they’ll certainly take their share. It’s your job to make sure you’re only paying what’s necessary. We offer Portland tax consulting, real estate tax strategies, and Oregon tax planning services designed to maximize your deductions and minimize your tax liabilities. We focus on the details so you can focus on growing your business.
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