Revenue Procedure 2009-20 provides an optional safe harbor treatment for taxpayers that experienced losses in certain investment arrangements discovered to be criminally fraudulent. It also describes how the Internal Revenue Service will treat a return that claims a deduction for such a loss and does not use the safe harbor treatment described in this revenue procedure.
Reporting Losses Resulting from Ponzi Schemes
The revenue procedure permits taxpayers who choose to use the safe harbor to deduct either 75% or 95% of the loss in the discovery year. Section 4.04 of Rev. Proc. 2009-20 defines the discovery year as the year in which the indictment, information, or complaint establishing the qualified loss is filed. For the Madoff Ponzi scheme’s victims, the discovery year is 2008.
The IRS provides two items of guidance to help taxpayers who are victims of losses from Ponzi-type investment schemes.
- Revenue Ruling 2009-9 provides guidance on determining the amount and timing of losses from these schemes, which is difficult and dependent on the prospect of recovering the lost money (which may not become known for several years).
Revenue Procedure 2009-20 simplifies compliance for taxpayers by providing a safe-harbor means of determining the year in which the loss is deemed to occur and a simplified means of computing the amount of the loss.
By making the safe-harbor election, however, taxpayers are precluded from the following:
- Deducting losses in excess of the 75%/95% amount in the discovery year;
- Filing returns or amended returns to exclude or recharacterize income reported with respect to the investment arrangement in tax years preceding the discovery year;
- Applying the claim-of-right provisions of Sec. 1341; or
- Applying the doctrine of equitable recoupment or the mitigation provisions in Secs. 1311–1314.
Whether a taxpayer who recovers amounts lost in a fraudulent investment scheme is required to include the recovery in income depends on whether the taxpayer claimed a tax deduction for the theft loss in any prior year. A taxpayer who has not yet claimed a tax deduction for the theft loss is not required to include in income a recovery from the trustee or receiver. Instead, the recovery will reduce the amount a taxpayer may eventually claim as a loss. A taxpayer who claimed a tax deduction for the theft loss, however, may be required to include the recovery in income, depending on the extent to which the theft loss deduction created a “tax benefit” for the taxpayer.
Although the availability of the safeharbor provisions of Rev. Proc. 2009-20 may be beneficial for many taxpayers, careful analysis will be required to determine the combination of tax strategies that will maximize the value of the theft losses incurred by a taxpayer. If you have or believe you have been the victim of a Ponzi scheme you should consult with your tax advisor to determine the appropriate tax reporting of the loss.