How does the mandate to report income from illegal activities in the US jibe with the Fifth Amendment?

Al Capone was famously taken down for tax evasion for not reporting income from his illegal activities. If someone were to report the income from illegal activities like a marijuana dispensary or a bribe, my understanding is that they would be then investigated/prosecuted for their disclosed activities. However, The Fifth Amendment states that:

No person ... shall be compelled in any criminal case to be a witness against himself,...

Since reporting income, even if illegal, is a mandate and the Fifth Amendment protects against someone being held as a witness against themselves, the law seems to be inconsistent. How does the mandate to report income from illegal activities in the US jibe with the Fifth Amendment right against self incrimination?

3 Answers
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The original 1913 Revenue Act only required the reporting of income from "lawful" sources. In the 1921 Revenue Act the word, "lawful" was removed requiring all income to be reported.

[IRS Publication 17] states:

Illegal activities. Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity.

In United States v. Sullivan in 1927, the U.S. Supreme Court ruled that it was constitutional to require that a tax return be filed to report income. If the filer believed information required to be filed would incriminate him then the filer could raise the issue on the form. The filer could not simply refuse to file.

Justice Holmes further wrote:

It is urged that, if a return were made, the defendant would be entitled to deduct illegal expenses, such as bribery. This by no means follows, but it will be time enough to consider the question when a taxpayer has the temerity to raise it.

In Garner v. United States in 1976, the Supreme Court ruled that a filer's income tax return that revealed himself to be a gambler could be used as evidence that the filer violated gambling laws.

An article in Forbes describes a taxpayer who filed their returns but refused to answer some questions related to their income, asserting a Fifth Amendment privilege.

The IRS attempted to impose a "frivolous return" penalty on the taxpayer for refusing to provide all information.

The Tax Court ruled that the taxpayer had a legitimate fear regarding disclosure of information related to failing to file a report of foreign bank and financial accounts.

The tax court found the taxpayer had filed the standard return, the return contained sufficient information and that a return doesn't need to be "completely correct" but, rather, "substantially correct."

The IRS had claimed that omitting some information because of fear of self-incrimination is frivolous.

The Tax Court found that the standard, Notice 2010-33, doesn't require that "all" information must be provided, simply that substantial information must be provided.

As a result, the penalty was removed and the taxpayer's assertion of Fifth Amendment privilege was found not to be "frivolous."

As the Tax Court ruling explains,

the Fifth Amendment privilege applies to tax returns, provided the taxpayer affirmatively claims the privilege on the return and does so before he files it.

In summary, it is still necessary to file a return; a blanket Fifth Amendment claim applying to the entire return is considered frivolous. However, the taxpayer must claim the privilege. Any incriminating information included on the return can be used against the taxpayer.

On your tax forms there is a field for how much of you income for the filing year was gained from illegal sources. It pretty much is a check box and then write the dollar value amount and how much of that do you need to write a check for the government for.

If Jimmy Jones robs a bank of $1,000,000 (Dr. Evil pose), he can get out of being investigated for Tax Fraud by checking the box, writing the dollar value and that factors into his annual income and calculates to the percent value he has to pay based on his tax bracket and other legitimate earnings. Jimmy Jones need not say what crime he committed to get that money, nor does he admit it was from a single criminal act. Only that he does not have tax paperwork for this money and has not had it deducted from his earnings.

This is not probable cause enough to get a warrant to search Jimmy Jones' property or financial transactions to look for illegal deposits of cash (deposits over $10,000 auto trigger some reporting, as do frequent sudden deposits that are close to that value). Because of this, Jimmy is not admitting to a crime and thus cannot claim this was forced testimony. All Mr. Jones is doing is admitting he benefited from a crime, which is not the illegal action of the crime... the action, which is still not attested to, is what makes it illegal.

In fact, with few exceptions, you can even deduct for certain expenses related to the commission of the crime you are paying taxes on. For example, it is illegal to deduct expenses for an illicit drug crime... but it is not illegal to deduct for legal expenses related to declared embezzlement of money from a business.

In U.S. v. Sullivan, the Supreme Court ruled that taxpayers must report illegal income.

This ruling did not repeal the 5th Amendment. (it couldn't).

It also did not authorize IRS to play catch-22 "gotcha" by rigging the game so the only way to report illegal income is to give up your 5th Amendment rights. If anything, it says the exact opposite.

IRS is painted into a corner. It must provide a viable means for taxpayers to report illegal income, which does not violate the 5th Amendment. IRS doesn't have a choice here.

Of course IRS has no reason to make this easier, and its officers can "err" in very bad ways -- so getting the details right is essential. That's where a great tax lawyer comes in.

Thank you for your interest in this question.
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