According to federal income tax law, the earner must also report illegal gains on his tax return for taxation of illegal income, since those too constitute his taxable income. This is the position in spite of any legal obligation that may arise to repay or return the same to the victim or aggrieved party.
A person’s taxable income is liable to federal income tax law, irrespective of whether the same has been earned legally or illegally. The earner of wrongful gains has legal obligation to include the same in gross income for federal income tax purpose since he can appropriate the proceeds of the same for his own enjoyment or use. There is also no consensual restriction on the disposition of such ill gotten funds though the application of other branches of law might later on compel him to part with it for good.
Cost or expenses of illegal or criminal activities are deductible against the income from there.
However, penalties or fines paid for violation of law are not deductible expenses. There is no deduction for any payment to an employee or officer of any government. Similarly there are no deductions for bribes, kickbacks or illegal gratifications if the payer is subject to termination of license or loss of privilege to do business for such payments.
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