Provides Guidance For Investment Fraud Losses
IRS has issued taxpayer guidance in an effort to clarify
and untangle tax matters surrounding investor frauds like
the Bernard Madoff scandal. Issued in March, Revenue Ruling
2009-09 clarifies the income tax law governing the treatment
of losses in such investor frauds. Revenue Procedure 2009-20
provides a safe-harbor method of computing and reporting
testimony before the Senate Finance Committee, IRS commissioner
Doug Shulman, said that Rev. Ruling 2009-09 provides guidance
on a number of issues relating to the tax treatment of theft
is no deduction limit for theft loss. A theft
loss from a Ponzi-type investment scheme is not subject
to the normal limits on investment losses, which typically
limit the loss deduction to $3,000 per year when it exceeds
capital gains from investments.
theft losses are not subject to limitations that are applicable
to “personal” casualty and theft losses.
The loss is deductible as an itemized deduction, but is
not subject to the 10 percent of AGI reduction or the
$100 reduction that applies to many casualty and theft
theft loss is deductible in the year the fraud is discovered,
except to the extent there is a claim with a reasonable
prospect of recovery. Determining the year of
discovery and applying the “reasonable prospect
of recovery” test to any particular theft is highly
fact-intensive and can be the source of controversy. The
revenue procedure accompanying this revenue ruling provides
a safe-harbor approach that the IRS will accept for reporting
Ponzi-type theft losses.
amount of the theft loss includes the investor's unrecovered
investment – including income as reported in past
years. The ruling concludes that the investor
generally can claim a theft loss deduction not only for
the net amount invested, but also for the so-called “phantom
income” that the promoter of the scheme credited
to the investor’s account, which the investor reported
as income on his or her tax returns for a prior year.
taxpayers have argued that they should be allowed to amend
tax returns for years prior to the discovery of the theft
to exclude the phantom income and receive a refund of
tax in those years. The revenue ruling does not address
this argument, and the safe-harbor revenue procedure is
conditioned on taxpayers not amending prior year returns.
can be carried back and forward. A theft loss
deduction that creates a net operating loss (NOL) for
the taxpayer can be carried back and forward to generate
a refund of taxes paid in other taxable years.
said that Rev. Proc. 2009-20 is intended to:
a uniform approach for determining the proper time and
amount of a theft loss.
Avoid difficult problems of proof in determining how
much income reported from the scheme was fictitious,
and how much was real.
Alleviate compliance burdens on taxpayers and administrative
burdens on the IRS that would otherwise result.
revenue procedure provides two simplifying assumptions that
taxpayers may use to report their losses:
theft loss. Although the law does not require
a criminal conviction of a scheme’s promoter to
establish a theft loss, it often is difficult to determine
how extensive the evidence of theft must be to justify
a claimed theft loss.
Proc. 2009-20 provides that the IRS will deem the loss
to be the result of theft if:
promoter was charged under state or federal law with
the commission of fraud, embezzlement or a similar crime
that would meet the definition of theft, or
promoter was the subject of a state or federal criminal
complaint alleging the commission of such a crime, and
Either there was some evidence of an admission of guilt
by the promoter or a trustee was appointed to freeze
the assets of the scheme.
harbor prospect of recovery. Once theft is discovered,
it often is difficult to establish the investor’s
prospect of recovery. Prospect of recovery is important
because it limits the amount of the investor’s theft
loss deduction. Prospect of recovery is difficult to determine,
particularly where litigation against the promoter and
other potentially liable third parties extends into future
revenue procedure generally permits taxpayers to deduct
95 percent of their net investment in the year of discovery,
less the amount of any actual recovery in the year of
discovery, and the amount of any recovery expected from
private or other insurance, such as that provided by the
Securities Investor Protection Corporation (SIPC). A special
rule applies to investors who are suing persons other
than the promoter. These investors compute their deduction
by substituting 75 percent of their investment.
Bernard Madoff pleaded guilt on March 13 to 11 counts of
fraud, his case is far from over. Tax and investment experts
expect the legal untangling to continue for some time. To
learn more on tax issues surrounding theft losses, download
Clifton Gunderson’s free whitepaper, The
Bernard Madoff Affair and a recording of our
on the same topic.