IRS gives investors in Ponzi schemes a tax break
— -- Taxpayers who lose money on investments in Ponzi schemes — including those with convicted financier Bernard Madoff — will be eligible for tax refunds or other relief under new IRS guidelines issued Tuesday.
In Ponzi schemes, new investors' money is used to cover the investments and gains of prior investors. They often wind up with nothing when the scams unravel. But that's often after they have paid capital gains taxes for years on what they thought was hefty investment income.
IRS Commissioner Douglas Shulman told Congress the guidelines will apply to all such victims and will provide an easy way for investors to recoup taxes paid on "fictitious income."
Under the guidelines, investors in some of these cases will be eligible for a "theft-loss" deduction not subject to the limits on normal capital losses from investments, Shulman told a Senate Finance Committee hearing.
Tom Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants, says the losses are being treated more like business losses than typical theft losses. Investors will be able to deduct 95% of losses immediately. Claims for the remaining 5% can be made in future years.
"For many people who lost millions of dollars, that's huge," Ochsenschlager says.
The Ponzi theft-loss deduction can be taken in the year the fraud is discovered, except when an investor has a "reasonable prospect" of recovering the lost money, Shulman told Congress. The deduction is available for any Ponzi-scheme losses previously reported as income. If deductions on the losses this year are greater than stated income, the deductions can be applied to tax returns back five years (for which a refund would be given) or forward up to 20 years against future income.
The guidelines clear up what had been confusing — and many say unfair — provisions of tax law relating to Ponzi-related losses in investment accounts. Donald Schapiro, a tax partner at law firm Chadbourne & Parke, says the income from the initial investment was previously treated as "phantom income" even though "if you hadn't reported that phantom income, you could have gone to jail."
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