Rev. Rul. 65-254

The Internal Revenue Service has been asked whether the provisions of sections 165 and 1341 of the Internal Revenue Code of 1954 are applicable with respect to repayment of embezzled funds.

The taxpayer in the instant case was employed as a full-time cashier. During the years 1959 through 1961 he embezzled from his employer the sum of 20 x dollars. In 1962, when the embezzlement was discovered, the taxpayer repaid the total amount embezzled.

Section 165 of the Code provides, in part, as follows:

(a) GENERAL RULE.-There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

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(c) LIMITATION ON LOSSES OF INDIVIDUALS.-In the case of an individual the deduction under subsection (a) shall be limited to-

(1) losses incurred in a trade or business;

(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; * * *

The proceeds of an embezzlement constitute gross income to the embezzler in the year of embezzlement. See Revenue Ruling 61-185, C.B. 1961-2, 9.

Each of the several acts of embezzlement by the instant taxpayer falls within the ambit of section 165(c)(2) of the Code. Accordingly, a deduction is allowable under section 165(a) of the Code, for the repayment of the embezzled funds for the taxable year in which the repayment is made. The allowable loss is deductible from adjusted gross income in computing taxable income provided the taxpayer does not elect to use the standard deduction or optional tax table.

Section 1341(a) of the Code provides rules for computation of tax where a taxpayer is entitled to a deduction in excess of $3,000, in respect of an item which was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item.

Section 1.1341-1(a)(2) of the Income Tax Regulations provides that for the purpose of this section `income included under a claim of right' means an item included in gross income because it appeared from all the facts available in the year of inclusion that the taxpayer had an unrestricted right to such item.

Inasmuch as the proceeds of an embezzlement are not received under a claim of right within the definition set forth, the taxpayer is not entitled to the benefit of section 1341 of the Code with respect to the repayment of embezzled funds.