Tax Deductions for Victims of Ponzi schemes
In a Ponzi scheme initial investors are paid with cash from subsequent investors.
There is little or no legitimate commerce.
Since Ponzi schemes involve the illegal taking of property with criminal intent, they are
deductible as theft losses on Schedule A under miscellaneous itemized deductions.
Casualty and theft losses are not reduced by 2% of Adjusted Gross Income and are not
subject to the overall limit on itemized deductions for high income taxpayers. Also,
since investments are transactions entered into for profit, the limitations on personal
losses from casualties and theft (subtract $500 per theft or casualty and 10% of
Adjusted Gross Income from total casualties and theft) do not apply.
A theft loss in a transaction entered into for profit (such as an investment) may create
or increase a net operating loss under IRC § 172 that can be carried back up to 3 years
and forward up to 20 years.
This treatment is much more favorable than that for investment losses that stem in
part from fraudulent activity without the specific intent to deprive the investor of
money. Such losses are capital losses reported on Schedule D. They offset capital
gains in full plus up to $3,000 per year of ordinary income.
The amount of a theft loss in a transaction entered into for profit is generally the
amount invested in the arrangement, less any amounts withdrawn or recovered. The
amount invested does not include amounts borrowed from the responsible group and
invested in the specified fraudulent arrangement, to the extent the borrowed amounts
were not repaid at the time the theft was discovered. However, it does include
fictitious earnings that were reinvested and that have been reported as income on the
investor’s tax returns.
The total must be reduced by claims as to which there is a reasonable prospect of
recovery. The taxpayer may have income or an additional deduction in a year
subsequent to the discovery year depending on the actual amount of the loss that is
eventually recovered.
The theft loss is deductible in the year the loss is discovered, provided that the loss is
not covered by a claim for reimbursement or recovery with respect to which there is a
reasonable prospect of recovery. The victim of a Ponzi scheme does not have to wait
for a conviction in a criminal case to file a claim. A claim may be filed upon the filing of
an indictment, information, or complaint by federal or state prosecutors in a criminal
proceeding.
Rev. Proc. 2009-20 provides an optional safe harbor for losses for which the discovery
year is a taxable year beginning after December 31, 2007. The safe harbor avoids
potentially difficult problems of proof in determining how much income reported in
prior years was fictitious or a return of capital, and alleviates compliance and
administrative burdens on both taxpayers and the Service.
A qualified investor that does not pursue any potential third-party recovery can deduct
95% of the qualified investment. A qualified investor that is pursuing or intends to
pursue any potential third-party recovery can deduct 75% of the qualified investment.
Any actual recovery and any potential insurance/SIPC recovery must be deducted from
the 95% or 75%.
For additional guidance see Rev. Rul. 2009-9 and Rev. Proc. 2009-20.
In a Ponzi scheme initial investors are paid with cash from subsequent investors.
There is little or no legitimate commerce.
Since Ponzi schemes involve the illegal taking of property with criminal intent, they are
deductible as theft losses on Schedule A under miscellaneous itemized deductions.
Casualty and theft losses are not reduced by 2% of Adjusted Gross Income and are not
subject to the overall limit on itemized deductions for high income taxpayers. Also,
since investments are transactions entered into for profit, the limitations on personal
losses from casualties and theft (subtract $500 per theft or casualty and 10% of
Adjusted Gross Income from total casualties and theft) do not apply.
A theft loss in a transaction entered into for profit (such as an investment) may create
or increase a net operating loss under IRC § 172 that can be carried back up to 3 years
and forward up to 20 years.
This treatment is much more favorable than that for investment losses that stem in
part from fraudulent activity without the specific intent to deprive the investor of
money. Such losses are capital losses reported on Schedule D. They offset capital
gains in full plus up to $3,000 per year of ordinary income.
The amount of a theft loss in a transaction entered into for profit is generally the
amount invested in the arrangement, less any amounts withdrawn or recovered. The
amount invested does not include amounts borrowed from the responsible group and
invested in the specified fraudulent arrangement, to the extent the borrowed amounts
were not repaid at the time the theft was discovered. However, it does include
fictitious earnings that were reinvested and that have been reported as income on the
investor’s tax returns.
The total must be reduced by claims as to which there is a reasonable prospect of
recovery. The taxpayer may have income or an additional deduction in a year
subsequent to the discovery year depending on the actual amount of the loss that is
eventually recovered.
The theft loss is deductible in the year the loss is discovered, provided that the loss is
not covered by a claim for reimbursement or recovery with respect to which there is a
reasonable prospect of recovery. The victim of a Ponzi scheme does not have to wait
for a conviction in a criminal case to file a claim. A claim may be filed upon the filing of
an indictment, information, or complaint by federal or state prosecutors in a criminal
proceeding.
Rev. Proc. 2009-20 provides an optional safe harbor for losses for which the discovery
year is a taxable year beginning after December 31, 2007. The safe harbor avoids
potentially difficult problems of proof in determining how much income reported in
prior years was fictitious or a return of capital, and alleviates compliance and
administrative burdens on both taxpayers and the Service.
A qualified investor that does not pursue any potential third-party recovery can deduct
95% of the qualified investment. A qualified investor that is pursuing or intends to
pursue any potential third-party recovery can deduct 75% of the qualified investment.
Any actual recovery and any potential insurance/SIPC recovery must be deducted from
the 95% or 75%.
For additional guidance see Rev. Rul. 2009-9 and Rev. Proc. 2009-20.
Jane E. Ritzinger, CPA, CFE
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