South Florida Estate Planning Law : Florida Estate Planning Lawyer & Attorney : David Shulman Law Firm : South FL Wills & Trusts

In testimony before Congress this morning, IRS Commissioner Douglas Shulman [No Relation] testified that the Service will be issuing guidance as to how victims of Ponzi schemes can treat their losses for tax purposes.  According to the New York Times:

The plan, which applies to victims of all Ponzi schemes, is likely to provide major relief to the victims of Mr. Madoff, who pleaded guilty last week to orchestrating what prosecutors say is the largest Ponzi scheme ever — one that could reach $65 billion and cover 13,000 investors.

The plan would ease existing rules governing what are known as theft-loss deductions, which are losses claimed by investors who are cheated by their investment advisers and others in Ponzi schemes and other frauds.

Under the plan, which has been reviewed by the congressional offices, the I.R.S. will allow investors who are not suing Mr. Madoff to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from Securities Investor Protection Corporation, the government-chartered fund set up to help protect investors of failed brokerage firms.

Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.

The I.R.S. is also relaxing the rules on how far back the losses can be carried. Current theft loss rules typically allow loss to be carried back 2 years and forward 20 years, but under the plan, the I.R.S. will allow losses to be carried back 5 years as well as forward 20 years.

Under the plan, investors must claim the loss as having happened in 2008.

 I will post any original sources when I find them.

UPDATE: The IRS has issued a Revenue Ruling (Rev. Rul. 2009-09) and a Revenue Procedure (Rev. Proc. 2009-20) (Thanks to Joe Kristan of Roth CPA for the links). Joe did his own reading and analysis of the releases.  My quick read is as follows:

First, the Service issued both a Revenue Ruling and a Revenue Procedure.  A Revenue Ruling generally states what the Service's posistion is on a specific area of law.  A Revenue Procedure sets forth methods for Taxpayers to comply.

Rev. Rul. 2009-09 answers the following questions:

1. Is a loss from criminal fraud or embezzlement in a transaction entered into for profit, a theft loss or a capital loss under s. 165 of the Internal Revenue Code? (The Service ruled it was a theft loss and not a capital loss)
2. Is such a loss subject to either the personal loss limits in 165(h) of the Code or the limits on itemized deductions in 67 and 68? (The Service ruled that the deduction that can be taken pursuant to the answer to 1 above is not subject to the limits of 67 and 68.
3. In what year is the loss deductible? (The Service ruled that a theft loss is deductible in the year in which the taxpayer discovers the loss, which is 2008 and should be deducted on 2008 returns filed in 2009.)
4. How is the amount of the loss determined. (The Service ruled that the amount of the deduction is the initial amount invested plus any additional amounts invested, reduced by any amounts withdrawn, and reduced by claims as to which there is a reasonable basis for recovery.  Therefore, for a Madoff investor, their loss is the initial investment, plus any additional investment, plus any amount that they reported on their income tax returns as gross income over the time of the investment, reduced by any money that was distributed to them. Also, if the Taxpayer has a reasonable chance of recovery of any property, they can not deduct that amount either.)

The Revenue Ruling also discussed Net Operating Losses, the Claim of Right doctrine, and the Statute of Limitations.  It provides that a taxpayer can treat these losses as a NOL, that there is NOT a benefit under s 1341 (the Claim of Right Doctrine), and that a Taxpayer can take a decution in 2008 for amounts taken into income for past years, even if the statute of limitations has expired.

The Revenue Procedure provides a "safe harbor" for Taxpayers -- meaning that if Madoff victims follow it, their returns will not be challenged by the IRS.  It provides for a deduction of 95% of the "qualified investment" a term defined in the Rev. Proc, if the taxpayer is not going to sue Madoff, and 75% if they are going to sue Madoff (or other Ponzi promoters).

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Although I'm sure that it is of little comfort to his victims who had their lives ruined (and there are quite a few of them here in South Florida), the United States Government has filed a notice of intent to seek the forfeiture of not only Bernard Madoff's assets, but also the assets of his wife, Ruth.  This comes on the heels of his guilty plea least week.

The list of assets to be seized includes:

1. Their Co-op located at 133 East 64th Street, Manhattan;
2. Their home located at 410 North Lake Way, Palm Beach, Florida;
3. One Leopard 23M Sport Yacht known as Bull;
4. One 2007 BMW 530i;
5. One 1999 Mercedes Benz CLK Class;
6. Silverware set owned in the name of Ruth Madoff valued at approximately $65,000;
7. Approximately $17,010,000 located at Wachovia Bank in Ruth Madoff's name; and
8. Approximately $45,000,000 in municipal bonds in Ruth Madoff's name. 

For some reason the government's document listed the tchotchkes first and the tens of millions of dollars last.

The full text of the Government's Notice of Intent to Seek Forfeiture of Certain Assets is located here.

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Time magazine published an article today discussing what many tax attorneys and CPAs had already been discussing amongst themselves on internet listservs and at wild and crazy tax attorney/CPA parties for the past few months -- the massive amount of tax refunds that are going to be filed for by victims of Bernard Madoff and other Ponzi crooks.  Per the article:

"I think we're going to see the IRS come out with guidelines very shortly," said Neil Tipograph, tax partner at New York-based, Imowitz Koenig & Co, LLP, an accounting firm specializing in private equity and feeder hedge funds. According to Tipograph and other tax experts, victims involved in Ponzis have four ways to reclaim taxes paid on fraudulent income, the first being a good old-fashioned "Theft Loss" deduction, which allows a person to go back three years and reclaim taxes paid. Currently, no deduction can be made on the original investment, especially if a SIPC claim has been made.

The second is a "Phantom Income Deduction," which allows you to remove the Ponzi income going back three years, but if you still have a loss you can carry it forward [i.e., apply it as a deduction against future gains] until the full loss is made up.

The third option, "Claim of Rights Credit," is most beneficial, he says. It allows victims to claim a credit for all taxes paid on Ponzi income going back to the first investment year on their 2008 tax return. The catch, according to Tipograph: "It's never been tested in regard to Ponzis." This option is typically used in insider trading cases, when tax monies need to be returned.

The last option is "Mitigation," which requires the taxpayer to go back and reopen each year's tax filing, back to the year of the first investment. There are some technical requirements related to this option.

"It's likely the IRS will just allow for the theft loss," said Tipograph. "It's not the best option for taxpayers, but is a reasonable way to handle this." But if you don't file by April 15, you can lose out on filing for 2005, Tipograph says, since there's a rolling three-year time limit.

I was really hoping that the IRS itself would issue guidance on the subject well before April 15, but as the clock ticks, that's looking more and more unlikely.

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