What to do if an employee steals from you: A clear guide for business owners.

What to do if an employee steals from you: Facts, myths, and the real legal path forward

Employee theft is one of the most emotionally and financially destabilising experiences a business owner can face. It combines personal betrayal with immediate cash flow damage and, in many cases, a long and frustrating encounter with the criminal justice and tax systems. For small and medium-sized businesses in particular, a single incident of embezzlement or fraud can threaten survival. This article examines a widely circulated anecdote often attributed to Frank Abagnale, the former con artist whose life inspired Catch Me If You Can, and uses it as a starting point to explain what is true, what is false, and what business owners should actually do if an employee steals from them. The goal is clarity, legality, and practical protection, not revenge fantasies that can backfire.

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The story usually appears in emails, talks, or online posts, often framed as a clever loophole that allows victims to recover money and achieve a sense of justice. It goes like this.

“One of the most common emails that I receive every day. Unfortunately, just about one every day. I can read the first paragraph, then close my eyes and read the rest to myself because unfortunately they’re pretty much the same. Dear Mr Abagnale, now I own a small graphics company in Southern California. I had a bookkeeper steal US$50,000 from me. I caught her, had her arrested, went to court. But in the second day of the trial, the district attorney leaned over and whispered in my ear, ‘Don’t come back.’ Two days later, the district attorney said the employee decided to cop a plea, took eight years’ probation, no restitution. As I write you today, I’m out US$50,000. I’m going to have to file bankruptcy. The employee is driving a brand new car, lives in a brand new house. I’m extremely frustrated in writing you is to ask you, is there not some recourse, some way that I can walk away from this with some closure or personal satisfaction? Yes, the government gives you a wonderful tool, but you have to use it. If I have an employee steal US$5,000, US$500, US$5 million, I file a 1099 on that employee. Under the rules of the IRS, money that is stolen by means of theft is taxable income.”

The anecdote continues by claiming that filing a Form 1099 achieves three outcomes. First, the business owner gets a tax write off for the stolen amount. Second, the owner receives a filing fee or reward from the IRS for reporting unreported income. Third, the IRS will aggressively pursue the thief, seizing assets, garnishing wages, and remaining immune to bankruptcy. The story culminates in the claim that threatening to file a 1099 is more effective than threatening jail time, because it pressures the thief into agreeing to a private repayment plan.

It is an appealing narrative, particularly for someone who feels abandoned by prosecutors and cheated by a system that seems to punish victims twice. However, while parts of the story are rooted in real tax law, the practical advice it promotes is incomplete, misleading, and in some situations legally dangerous.

To understand what to do if an employee steals from you, it is essential to separate fact from fiction

The first core claim in the story is that stolen money is taxable income. This is true. Under United States tax law, income is broadly defined, and it does not matter whether that income was earned legally or illegally. The IRS has been explicit on this point for decades. Income from illegal activities, including theft, fraud, and embezzlement, must be reported by the person who received it. This principle is historically well established. The most famous example remains Al Capone, who evaded conviction for violent and organised crime but was ultimately imprisoned for tax evasion. If an employee steals US$50,000, that US$50,000 is taxable income to the employee in the year it was stolen.

Where the story begins to drift into questionable territory is the claim that the victim can or should file a Form 1099 for the stolen funds. A Form 1099, whether 1099-MISC or 1099-NEC, is designed to report payments made in the course of a trade or business to non-employees. It documents compensation, rents, prizes, and other legitimate categories of payment. Theft is not a payment. It is not a business transaction. While it may be technically possible to submit a 1099 with a thief’s details and an amount, doing so is a creative misuse of the form rather than its intended purpose.

Tax professionals generally caution against using a 1099 to report theft. The IRS may question or reject it, and the filer may be asked to justify why a criminal act was reported as a business payment. There is also a risk that the act of filing could create confusion about the nature of the relationship between the parties. The correct method for reporting suspected tax fraud or unreported illegal income is Form 3949-A, the Information Referral form. This allows a victim to alert the IRS to potential tax violations without mischaracterising the nature of the transaction.

Another major claim in the anecdote is that filing a 1099 creates a tax write off for the victim. This is misleading. The tax deduction arises from the theft itself, not from the filing of a form. Under Section 165 of the Internal Revenue Code, businesses can deduct losses resulting from theft or embezzlement, provided the loss is not compensated by insurance and is properly documented. Police reports, court records, internal investigations, and accounting evidence all support such a deduction. A 1099 is not required to claim it, and filing one does not increase or unlock the deduction.

The story also asserts that the victim receives a filing fee or whistle-blower reward, sometimes described as up to one third of the amount involved. This is largely false in the context described. The IRS does operate a Whistleblower Office, and it does pay awards ranging from 15 percent to 30 percent of amounts collected. However, those awards apply only in cases where the disputed tax, penalties, and interest exceed US$2 million, and where the information provided leads directly to recovery. A US$50,000 theft does not meet this threshold, and there is no automatic payment for filing a 1099 or submitting a tip. There is no filing fee paid to the victim in these circumstances.

One point in the story that is broadly accurate is the description of the IRS as a persistent and powerful collector. Tax debts are significantly harder to discharge in bankruptcy than consumer debts. While some older tax liabilities can be discharged under strict conditions, the IRS generally has far more leverage than a private creditor. This reality is part of what makes the anecdote emotionally compelling. It taps into the idea that the IRS can deliver a form of justice when the criminal courts do not.

The most serious problem with the story lies in its promotion of threats as a collection tool. Telling a former employee, “Pay me back or I will file a 1099 and report you to the IRS,” is not clever leverage. It can cross into criminal territory. In many jurisdictions, using the threat of reporting someone to law enforcement or a regulatory body in order to obtain money can constitute extortion or the compounding of a crime. Even if the underlying facts are true, the act of making reporting conditional on payment is legally risky. A skilled defence attorney could argue that the victim attempted to use coercion for personal gain, potentially exposing them to charges or civil liability.

This is the critical distinction that the anecdote glosses over. Reporting a crime or tax violation is lawful. Bargaining with the threat of reporting is where the danger lies. The law draws a line between cooperation with authorities and private enforcement through intimidation.

So what should a business owner actually do if an employee steals from them?

The first step is to secure evidence and stop the loss. Access should be revoked immediately, accounts frozen where possible, and systems audited. Documentation is essential, not only for criminal proceedings but for insurance claims and tax deductions. The second step is to report the theft to law enforcement. While the criminal justice process can be frustrating, a police report establishes a formal record that is often required for downstream remedies.

The third step is to consult a qualified accountant or tax professional. Theft losses can have complex tax implications, particularly if they span multiple tax years or involve payroll taxes. Claiming the deduction correctly can materially reduce the financial impact of the loss. This is where many business owners make costly mistakes by either failing to claim what they are entitled to or claiming it incorrectly.

If the employee has not reported the stolen funds as income, the victim can report suspected tax fraud to the IRS using the appropriate channels, such as Form 3949-A. This should be done without communicating threats or conditions to the perpetrator. Once reported, the matter is in the hands of the authorities.

Civil recovery is another avenue, though it is often limited by the thief’s ability to pay. A civil judgment is only as valuable as the assets behind it. In some cases, structured repayment agreements can be negotiated through attorneys, ensuring that they are legally sound and not coercive.

What to do if an employee steals from you: Facts, myths, and the real legal path forward 8

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Throughout this process, it is vital to understand that emotional satisfaction and legal safety are not always aligned. The desire for closure is human, but acting on bad advice can turn a victim into a defendant.

From a broader perspective, employee theft highlights the importance of preventative controls. Segregation of duties, regular audits, mandatory holidays, and external oversight all reduce the risk of long term fraud. While prevention does not help after the fact, it can prevent recurrence and reassure stakeholders that lessons have been learned.

When it comes to the tax side of this ordeal, complexity is the enemy of recovery. Theft losses, amended returns, documentation standards, and reporting obligations can overwhelm even experienced business owners. Mistakes can lead to audits, penalties, or missed deductions at a time when financial resilience is already strained.

For employers who want to handle these issues correctly without immersing themselves in technical tax law, using a reputable tax preparation and filing service is a rational choice. Services like Tax ACT are designed to guide individuals and businesses through deductions, losses, and reporting requirements in a structured and compliant way. Rather than experimenting with legally questionable tactics or relying on anecdotal shortcuts, using an established platform reduces risk and ensures that the financial consequences of employee theft are addressed properly.

Employee theft is painful, unfair, and often poorly resolved by the systems meant to address it. The law does provide tools for mitigation and recovery, but those tools must be used carefully. The popular story told by Frank Abagnale contains a kernel of truth about taxable income, but its practical advice is exaggerated at best and dangerous at worst. Real protection comes from documentation, professional guidance, and lawful reporting, not threats. If you want closure without compounding your problems, focus on doing things correctly, and let specialists and systems like Tax ACT handle the complexity so you can focus on rebuilding your business.

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