Tax Alert: IRS Issues Guidance for Handling Ponzi Scheme-Related Losses
3/19/2009
On March 17, the Internal Revenue Service (IRS) issued Revenue Ruling 2009-9 and Revenue Procedure 2009-20 to provide guidance for handling Ponzi scheme-related theft losses.
Revenue Ruling 2009-9 finds the following:
The loss was entered into for profit, is a theft loss and is deductible as an itemized deduction that is not subject to the 10% AGI reduction. It is deductible in the year the theft loss is discovered (2008 for Madoff-related losses).
The amount of theft loss is generally the amount of investment less amounts withdrawn, reduced by recoveries and reduced by claims where there is a reasonable prospect of recovery. If the income prior to discovery of the theft was included in gross income and reinvested, the theft loss is increased by the reinvested amount.
The theft loss may create a net operating loss and the new five-year carryback for eligible small businesses may apply.
Under Revenue Procedure 2009-20, if the qualified investor follows the procedures described, the IRS will not challenge the following treatment by the qualified investor for a qualified loss:
The loss is deducted as a theft loss and the taxable year in which the theft was discovered is the discovery year (2008 for Madoff-related losses).
The amount of theft loss deduction is:
- 95% of the theft loss as described above for a qualified investor that does not pursue any potential third-party claim or
- 75% for a qualified investor that is pursuing any potential third-party claim less
- The sum of any actual recovery and any potential insurance/SIPC recovery
- The amount of deduction calculated is not further reduced by potential direct recovery or potential third-party recovery
According to the Revenue Procedure if the taxpayer does not use the safe harbor method above:
- They are subject to all applicable provisions governing the deductibility of losses as a theft loss. The taxpayer must establish that the loss was a theft and the theft was discovered in the year the taxpayer claims the deduction. The taxpayer must also establish that no claim for reimbursement of any portion of the loss exists with respect to where there is a reasonable prospect of discovery.
- The IRS will allow the inclusion in basis of any phantom income from prior years that was not amended where the statute of limitation has closed.
- Returns claiming theft loss deductions are subject to examination by the IRS.
We will discuss with each client the ramification of these IRS announcements and any alternatives that might be available to them. Please contact your J.H. Cohn professional at 877-704-3500 with any questions.
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