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IRS Issues Guidance for Claiming Theft Loss Deduction for Losses From Ponzi Scheme

IRS ISSUES GUIDANCE FOR CLAIMING THEFT LOSS DEDUCTION FOR LOSSES FROM PONZI SCHEME

Under tremendous pressure from taxpayers and politicians, the Internal Revenue Service has issued guidance on how to file claims for theft losses resulting from Ponzi Schemes.

IRS Revenue Ruling 2009-9 and Revenue Procedure 2009-20 issued this week allows taxpayers to claim a theft loss in 2008 and carryback excess losses for five years. The guidance allows taxpayers the ability to deduct the principal amount of their investment and any earnings they have reported that remained in the Ponzi scheme. This safe harbor is intended to help cheated investors gain some relief by providing a relatively straightforward method to calculate and deduct losses from this investment fraud.

"During the last few months, we have been working with a number of taxpayers regarding how to maximize tax savings in light of these losses," commented Louis C. Grassi, Managing Partner of Grassi & Co. "We have also been reaching out to public officials to offer guidance in this matter. We are pleased that the IRS has responded favorably and offered this tax relief. The Madoff fraud and other recent Ponzi schemes have had devastating impacts on thousands of victims," Grassi added. "This offers a substantial measure of financial relief to those who were victimized."

Theft loss deduction equals the amount invested in the scheme, less any amounts withdrawn, reimbursements, and claims as to which there is a reasonable prospect of recovery. The deductible amount also includes any fictitious income that was reported to the investor in years prior to the discovery of the theft that was included in the investor's gross income, and reinvested in the scheme. Up to 95% of qualified losses from a specified fraudulent arrangement, calculated through detailed definitions and formulas, may be deducted by a qualified investor as a theft loss.

To take advantage of the safe harbor, taxpayers must complete a statement and file it with their tax return, amended return or claim for refund. The statement requires the taxpayer to provide specified information and computations. The taxpayer must also comply with all conditions set forth in the IRS statement, including the following:

1. The taxpayer will not deduct any amount of the theft loss in excess of the amount permitted by the IRS guidance.

2. The taxpayer will not file returns or amended returns to exclude or recharacterize income from the fraudulent arrangement for previous tax years.

Investors who unknowingly invest in a Ponzi scheme, such as the Madoff investment fund, through an intermediary fund or investment advisor are not covered by these safe harbor provisions. However, the intermediary investment fund may itself qualify to claim the loss deduction under the safe harbor.

Some of the major issues that the guidance addressed include:

1. Taxpayers who recognized phantom income as capital gains would still be entitled to a deduction, regardless of the manner in which the initial income was reported.

2. Taxpayers using the safe harbor in this provision cannot go back to prior-year returns to remove phantom income. The entire loss must be claimed in the year of discovery.

It is imperative that you speak with your tax advisor to make sure you are getting the proper advice with regard to claiming losses from Madoff or other Ponzi schemes. Each situation will require detailed analysis of the facts and circumstances to allow taxpayers the correct theft loss deduction and highest refund from the IRS and your local, state and city taxing authorities. Currently, we are still waiting for guidance from local, state and city taxing authorities to see if they will follow the IRS lead.

Please feel free to contact your Grassi Tax Advisor or Grassi Tax Partner Jed Dallek at (516) 336-2430 or via e-mail at jdallek@grassicpas.com to discuss how these changes may affect your situation.  For more information on the Grassi Tax Team, visit http://www.grassicpas.com/.