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:
- 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)
- 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.
- 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.)
- 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).