IRS allowing tax relief for some Madoff victims

The Internal Revenue Service is allowing tax relief and refunds for some investors who paid taxes on earnings from their investments with Bernard Madoff that turned out to be nonexistent, the head of the agency told Congress Tuesday. IRS Commissioner Douglas Shulman said the agency is issuing guidelines for taxpayers who are victims of losses from Ponzi investment schemes such as the massive Madoff swindle. Madoff investors should have been reporting earnings from their investments with him through the years and thus paid taxes on those earnings. Given that some of those were "phantom" profits, investors have said they should be entitled to refunds of the taxes they paid. Investors in some of these cases are entitled to a "theft loss" deduction, not subject to the limits on normal capital losses from investments, according to the IRS guidelines, Shulman testified at a Senate Finance Committee hearing. The theft loss deduction can be taken in the year a fraud is discovered, except to the extent an investor has a reasonable prospect of recovery of the lost money, Shulman said. Determining the amount and timing of losses from Ponzi schemes is "factually difficult" and depends on prospects for recovering the lost money, which may not become clear for years, he noted. In Ponzi schemes, early investors are paid returns from money put in by later investors. "Some taxpayers have argued that they should be permitted 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," Shulman testified. The new IRS guidelines do not address that argument, he said. To date, about $1 billion in assets have been identified for Madoff investors, just a small portion of the $65 billion he told his 4,800 investors that he had on hand in November. Authorities say they believe the figure included what would have existed if much smaller original investments had grown for decades. By some estimates, the IRS could be out as much as $17 billion in lost tax revenue from refunds to investors who earned fictitious profits in the Madoff scheme.