Situation: Your client was a victim of a Ponzi scheme and wants to know whether he can deduct a loss on his tax return for the fraudulent behavior of the investment adviser.
Solution: The
Internal Revenue Service recently issued Revenue Procedure 2009-20, which offers a safe harbor for Ponzi scheme victims and clarifies Rev. Proc. 2009-09. Both procedures address the tax treatment of losses from criminally fraudulent investment arrangements that take the form of a Ponzi scheme. This type of loss is considered a theft loss.
Rev. Proc. 2009-20
Rev. Proc. 2009-20 provides an optional safe harbor for taxpayers.
The safe harbor loss deduction is as follows:
1. Multiply the amount of the qualified investment by:
a. 95%, for a qualified investor that does not pursue any potential third-party recovery or
b. 75%, for a qualified investor that is pursuing or intends to pursue any potential third-party recovery
2. Subtract the sum of any actual recovery and any potential insurance recovery.
The taxpayer must file Form 4684, “Casualties and Thefts,” with their tax return, and the front of Form 4684 should be marked “Revenue Procedure 2009-20.”
The taxpayer should then complete and sign the statement provided in Appendix A of Rev. Proc. 2009-20 and attach it to a timely filed federal income tax return for the year the loss is discovered.
If a taxpayer chooses not to apply the safe harbor treatment provided by Rev. Proc. 2009-20, the theft loss is subject to all of the generally applicable provisions governing the deductibility of losses under Internal Revenue Code Section 165.
Rev. Proc. 2009-09
Rev. Proc 2009-09 provides that for federal income tax purposes, “theft” is a word of general and broad connotation, covering any criminal appropriation of another’s property to the use of the taker, including theft by swindling, false pretenses and any other form of guile.
A taxpayer claiming a theft loss must prove that the loss resulted from a taking of property that was illegal under the law of the jurisdiction in which it occurred and was done with criminal intent. The taxpayer need not show a conviction for theft.
A loss deduction is allowed without taking into consideration the limits for casualty losses under IRC Section 165(h). That is, the losses are subjected to the $100 floor and do not have to exceed 10% of adjusted gross income. The loss is allowed to the full extent as an itemized deduction.
The investor may deduct the loss in the year of discovery. If, in a later year, the investor recovers an amount that exceeds the loss, the excess amount is included in gross income. The amount of the loss is generally the amount invested in the arrangement, less amounts withdrawn, if any, reduced by reimbursements or recoveries, and reduced by claims as to which there is a reasonable prospect of recovery.
Prior to filing a tax return, your client should consult a qualified tax adviser.
