Reporting Losses Resulting from Ponzi Schemes

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.

 

Quick Tax Facts About Capital Gains and Losses

Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments. When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for is a capital gain or a capital loss.

Do you have questions about reporting gains and losses on your tax return?

Additional information on capital gains and losses is available in Publication 550Investment Income and Expenses, and Publication 544,Sales and Other Dispositions of Assets. If you sell your main home, refer to Topics 701 and 703, and Publication 523Selling Your Home

 

Here are some facts from the IRS about Capital Gains and Losses:

  • Almost everything you own and use for personal purposes, pleasure or investment is a capital asset.
  • When you sell a capital asset, the difference between the amount you sell it for and your basis, which is usually what you paid for it, is a capital gain or a capital loss.
  • You must report all capital gains.
  • You may deduct capital losses only on investment property, not on property held for personal use.
  • Capital gains and losses are classified as long-term or short-term, depending on how long you hold the property before you sell it. If you hold it more than one year, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
  • Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss. Net short-term capital gains are subject to taxation at your ordinary income tax rate.
  • The tax rates that apply to net capital gain are generally lower than the tax rates that apply to other income and are called the maximum capital gains rates.
  • If your capital losses exceed your capital gains, the excess can be deducted on your tax return, up to an annual limit of $3,000 ($1,500 if you are married filing separately).
  • If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that next year.
  • Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.

Quick Tax Facts About Capital Gains and Losses

Capital gains rates are designed to encourage long-term investing. Most people can get a significant advantage from holding stock investments for more than one year:

 

Tax Bracket Capital Gain Tax Rate
Short Term Long Term
10% 10% 0%
15% 15%
25% 25% 15%
28% 28%
33% 33%
35% 35%
39.6% 39.6% 20%

Short term gains on stock investments are taxed at your regular tax rate; long term gains are taxed at 15% for most tax brackets, and zero for the lowest two.

For more information about reporting capital gains and losses, get Publication 17, Your Federal Income Tax, and Publication 550, Investment Income and Expenses, available below or by calling 800-TAX-FORM (800-829-3676).

 

Links related to reporting Capital Gains and Losses:

Publication 17, Your Federal Income Tax

Publication 550, Investment Income and Expenses (PDF 516K)