No doubt you’ve heard about the pain and losses inflicted by Bernie Madoff’s Ponzi scheme. Fortunately, the IRS has responded to taxpayers’ cries for guidance on how to treat those losses by issuing advance copies of Revenue Ruling 2009-9 and Revenue Procedure 2009-20.
Revenue Ruling 2009-9
In a nutshell, provides that generally:
A loss from criminal fraud or embezzlement in a transaction entered into for profit is a theft loss, and will be treated as an ordinary loss (and not a capital loss).
A theft loss in a transaction entered into for profit is deductible as an itemized deduction and is not subject to the personal loss limits of $100 ($500 for years beginning in 2009), and 10% of Adjusted Gross Income (“AGI”).
The loss is also not subject to the disallowance of miscellaneous itemized deductions that don’t exceed 2% of Adjusted Gross Income or the overall itemized deduction limit – reduction by the lesser of (1) 3% of the excess AGI over $100,000 ($50,000 for married filing separate) adjusted for inflation, or (2) 80% of the amount of itemized deductions otherwise allowable for that year.
The loss is deductible in the year in which the loss is discovered, provided that the loss is not covered by a claim for reimbursement or recovery where there is a reasonable prospect of recovery.
The amount of the deductible loss is equal to the basis of the property that was lost, less any reimbursement or other recovery.
The theft loss may give rise to a Net Operating Loss (“NOL”), which may be carried back 3, 4, or 5 years and forward for 20 years depending on the taxpayer’s circumstances.
Revenue Procedure 2009-20
Provides optional “safe harbor” treatment for taxpayers that incurred losses in certain investment arrangements discovered to be criminally fraudulent.
Acknowledges that a number of taxpayers have suffered significant losses from various fraudulent investment schemes, often in the form of so-called “Ponzi” schemes.
Highlights the potential difficulty of establishing proof in determining how much income reported in prior years was fictitious (vs. a return of capital), as well as the corresponding compliance and administrative burdens on both taxpayers and the IRS.
Further recognizes that whether investors meet the requirements for claiming a theft loss for an investment are highly factual determinations that often cannot be made by taxpayers with certainty in the year the loss is discovered.
References Revenue Ruling 2009-9 (discussed above), which describes the proper income tax treatment for losses resulting from these schemes.
Applies to “qualified investors.” This generally includes U.S. taxpayers that (1) didn’t have actual knowledge of the fraud before it became known to the general public, (2) weren’t investing in a “tax shelter,” and (3) that transferred cash or property to a specified fraudulent arrangement (not including solely in a fund or other entity that itself invested in the fraudulent arrangement; however, that fund might itself be a qualified investor).
Permits qualified investors who suffer qualified losses from specified fraudulent arrangements to deduct most of the loss in the year the loss was discovered (i.e., the year in which the indictment, information, or complaint is filed against the accused fraudster(s)). Required steps by the taxpayer suffering the loss include:
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• Multiplying the amount of the qualified investment by either (1) 95%, for a qualified investor that does not pursue any potential third-party recovery, or (2) 75%, for a qualified investor that is pursuing or intends to pursue any potential third-party recovery.
Note: Potential third-party recovery means the amount of all actual or potential claims for recovery for a qualified loss, as of the last day of the discovery year, that do not represent (1) Potential insurance/SIPC recovery as described below, or (2) Potential direct recovery. Potential direct recovery means the amount of all actual or potential claims for recovery for a qualified loss, as of the last day of the discovery year, against the responsible persons.
• Subtracting from the above amount the sum of any actual recovery and any potential insurance/SIPC recovery. The result is the available deduction.
Note: Potential insurance/SIPC recovery means the sum of the amounts of all actual or potential claims for reimbursement for a qualified loss that, as of the last day of the discovery year, are attributable to (1) Insurance policies in the name of the qualified investor; (2) Contractual arrangements other than insurance that guaranteed or otherwise protected against loss of the qualified investment; or (3) Amounts payable from the Securities Investor Protection Corporation (SIPC), as advances for customer claims under the Securities Investor Protection Act of 1970, or by a similar entity under a similar provision.
• Completing Form 4684 - Casualties and Thefts, with the annotation “Revenue Procedure 2009-20” at the top.
• Completing, signing, and attaching the statement provided in Appendix A of the Revenue Procedure to the taxpayer’s tax return. The statement identifies the taxpayer, the computation of the deductible loss, and the taxpayer’s agreement to comply with the terms of the Revenue Procedure (including the inclusion in income of any future recoveries deducted under this pronouncement). |
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For further details, these documents are available on the IRS website as follows:
• Revenue Ruling 2009-9: [CLICK HERE]
• Revenue Procedure 2009-20 [CLICK HERE]
As always, please call us if you would like to discuss.
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Your Tax Partners, |
Mark G. Cook, CPA, Partner
Steven J. Cupingood, CPA, Partner
John A. Eckweiler, CPA, Partner
Andrew L. Gantman, CPA, Partner
Donald G. Leve, CPA, Partner
Richard A. Linder, CPA, Partner
Carl H. Sasaki, CPA, Partner
Thomas E. Wendler, CPA, Partner
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