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Nick Hodges CPA/PFS, MBA, CFP
Nick Hodges CPA/PFS, MBA, CFP
Certified Public Accountant and Certified Financial Planner
Fullerton, California

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TAX TIPS: Attention Madoff Victims - Two IRS Solutions to Recoup Your Losses

If you or someone you know was scammed by Bernie Madoff’s Ponzi scheme, you might have some recourse for your losses via your income tax return filings. The IRS has provided two avenues that might provide some relief.
Written Jan 18, 2010, read 502 times since then.

 

Did you or someone you know get scammed by the famous Bernie Madoff, current King of the Ponzi schemes?  If so, you might have some recourse for your losses via your tax return filings.  If you’re embarrassed by what happened, you might be tempted to try to handle filing for these deductions yourself.  But, do you know enough about filing and amending tax returns to answer questions like these:

  • Do you go back and amend all your prior-year tax returns, reversing all the income you claimed from the fraudulent paper statements you received?
  • What if some of those prior years are “closed” to you now, because they are past the statute of limitations, which does not allow you to file an amended tax return?
  • Once you know the amounts you lost, do you know how to calculate the losses you can claim?
  • Do you know the difference between an IRS theft loss and an IRS capital loss?

Solution #1:  The ‘Theft Loss’ deduction
Well, the IRS felt your pain this year and decided to help you out.  Really!  The IRS published Rev Proc 2009-20, issuing safe harbor guidance on how to treat “Ponzi” schemes like Madoff’s.  Under this ruling, such schemes are entitled to a theft loss deduction under IRS Code Sec 165.  In addition, IRS Rev Rul 2009-9 identifies that a theft loss is deductible in the year it is discovered.  Does this mean you don’t have to go back and amend your prior returns?  Well, yes and no. 

Before you know the answer, you have to identify the amount of your theft loss.  According to IRS Code Sec 165, the amount of the theft loss deduction includes the amount you invested directly with Madoff, less any amounts withdrawn including reimbursements.  More importantly, the deductible amount also includes any fictitious income that was reported to the investor in the years prior to the discovery of the theft that was included in the investor's gross income, and subsequently reinvested in the scheme.  Well, that sounds simple enough until you discover this:  to the extent an investor's theft loss deduction creates or increases a net operating loss in the year the loss is deducted, the investor may carry back that loss for up to three years, and carry losses forward for up to 20 years.  Great.  What should you do next; do you amend your past three years’ tax returns to capture more of the theft loss deduction? 

Solution #2:  The ‘Capital Loss’ Claim
What if you invested in Madoff indirectly?  You know – those ‘feeder’ mutual funds that Bernie used to scam thousands more from folks like you.  Those losses do not qualify for the theft loss deduction.  According to the IRS, you have incurred a capital loss.  Capital losses may only be applied against all capital gains.  In addition, you may deduct up to $3,000 against other income.  Losses beyond your capital gains and the $3,000 limit have to be carried forward into future years.  Do you have the experience and technology to properly calculate and carry forward this kind of information?  Do you really want to have to manage this all yourself?

Now that you know the IRS’s two solutions for how you might recoup some of your losses in the Bernie Madoff /Ponzi scheme, I encourage you or the victim you know to work with an experienced Tax Preparer or Certified Public Accountant (CPA) to get all the tax breaks you deserve.

It’s always easier to prevent mistakes than it is to correct them after the fact.  Working with an experienced Tax Preparer or CPA can help protect you from these kinds of errors.  The better lesson here is to NEVER deal with anyone who asks you to write an investment check directly to them or a company they control.  But you already knew that didn’t you?

Learn more about the author, Nick Hodges CPA/PFS, MBA, CFP.

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Article tags

  • tax
  • income tax
  • irs
  • madoff
  • ponzi scheme
  • tax preparer
  • cpa
  • certified public accountant
  • tax tips
  • theft loss
  • capital losses
  • amended tax return
  • feeder mutual funds

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