Helping a Church Member Pay Back Embezzled Funds

Lending a hand can lead to significant tax issues.

United States v. Hairston, 96 F.3d 102 (4th Cir. 1996)

Assume that a member of your church is accused of embezzling money from her secular job, and that your church assists her in paying back the embezzled funds. Such assistance is generous and understandable. However, it may have unforeseen legal and tax consequences, as illustrated by a recent federal appeals court ruling.

Reduction in sentencing. A church member embezzled more than $600,000 from a bank where she was employed as a branch manager. She spent all the embezzled funds on personal items and church-related activities. She was indicted for embezzlement, and pled guilty. Through the assistance of friends and her church, she was able to pay back $250,000 of embezzled funds. The trial court gave her a reduced sentence because of this restitution, but a federal appeals court ruled that this was improper. The court agreed that restitution can result in a reduced sentence if it "indicates an extraordinary acceptance of responsibility." Such was not the case here, however, since: (1) less than half of the embezzled funds were returned; (2) most of the returned funds came from the woman's friend's and from her church; and (3) the woman did not make any restitution until after she had been criminally indicted, in the hope of receiving a reduced sentence.

Tax issues. There are a number of tax issues associated with the church's assistance in paying back some of the embezzled funds. These include: (1) Did individual members contribute funds for this purpose to their church? If so, such contributions would not be deductible since they were earmarked for the benefit of a private individual and did not further the church's exempt purposes. (2) Since the church's participation in paying back funds embezzled by a church member did not further its exempt purposes, the church's tax-exempt status was jeopardized. (3) The church's payments may have resulted in taxable income to the embezzler, since the church was relieving her of a legal obligation. Of course, friends could make tax-free gifts directly to the embezzler to assist her in paying back the embezzled funds, but such gifts would not be deductible by the donors.

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