James embezzled $738k from his
employer. He was caught.
In addition to criminal
penalties for embezzlement, the IRS stepped in and claimed that the $738k
should be counted in James' gross income. James disagreed.
James argued that since a
person is legally obligated to repay money that they steal, they've
received no income in the same way
as a person receives no income from taking out a loan. So there should
be no tax liability.
The US Supreme Court found for
The US Supreme Court found
that found that there was a material difference in the intention of the taxpayer to repay the money. So the
money should be considered to be gross income, even though there was an obligation to repay.
The Court noted that nothing
in the 16th Amendment
prevented taxing illegal income.
DOJ wanted to go after
criminals (like Al Capone), and the powers of the IRS can go beyond the
powers of DOJ (e.g. IRS makes you file taxes, but DOJ can't ask you to
file a list of your felonies). So they wanted illegal income to count as income so the IRS could go after them.
In this case, James avoided
prison for embezzlement, but he was eventually sentenced to three years
in prison for tax evasion.