Victims of Bernard L Madoff’s huge investment fraud will be able to claim a tax deduction related to the bulk of their losses. Under the plan, investors must claim the loss as having happened in 2008. Investors who have already filed 2008 returns should file amended returns claiming the theft-loss deduction. The plan will apply to victims of all Ponzi schemes.
The I.R.S. plan eases rules governing theft losses, which are deductions claimed by investors who are cheated by their advisers and others in Ponzi schemes and similar frauds.
Current theft loss rules typically allow losses to be carried back three years and forward 20 years, but the I.R.S plan will allow carrybacks of as many as five years, generally if the loss is for a small business with gross annual receipts of less than $15 million.
Under the plan, the I.R.S. will allow investors, including those who are suing Mr. Madoff, to claim a theft loss equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from the Securities Investor Protection Corporation, the government-chartered fund formed to help protect investors in failed brokerage firms. A theft loss from a Ponzi scheme is an ordinary loss and not a capital loss
Investors who are suing third-parties involved in such a scheme, and who, as a result, may have some prospect of recovery, are permitted to claim a deduction equal to 75 percent of their investments.
For people who invested with Mr. Madoff through retirement plans, like 401(k)s and individual retirement plans, the picture is more complicated because such money was already invested on a tax-free basis. Generally, if the investment was deductible when it was made, such investors can’t take a loss.
When computing losses, investors are not permitted to include any taxes they paid on what turned out to be fictitious income. In other words, those taxes can not be added to your basis to increase any loss. For example, before December 2008, you reported $10,000 of fictitious income and paid $2,000 of income tax on that income. The $2,000 paid in tax can not be added back to compute your theft loss.
More information is provided in two Revenue Rulings released by the IRS at www.irs.gov; Revenue ruling 2009-9 and, Revenue Procedure 2009-20.
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