Ponzi

By Brian R. Jenney

Ponzi schemes are occurring all too often across the United States and Michigan. It is occurring so often that Attorney General Bill Schuette has issued a consumer alert to the citizens of Michigan (www.michigan.gov/ag) and the IRS has developed 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.

1. The investor is entitled to a theft loss, which is not a capital loss. A theft loss from a Ponzi investment scheme is not subject to the normal limits on losses from investments, which typically limit the loss deduction to $3,000 per year when it exceeds capital gains from investments.

2. The “investment” theft losses are not subject to limitations that are applicable to “personal” casualty and theft losses. The loss is deductible as an itemized deduction and is not subject to the 10 percent of AGI reduction or the $100 reduction that applies to many casualty and theft loss deductions.

3. The theft loss is deductible in the year the fraud is discovered, except to the extent there is a claim with a reasonable prospect of recovery. Determining the year of discovery and applying the “reasonable prospect of recovery” test to any particular theft is highly fact-intensive and can be the source of controversy. Rev. Proc. 2009-20 provides a safe-harbor approach that the IRS will accept for reporting Ponzi-type theft losses (see below).

4. The amount of the theft loss includes the investor’s unrecovered investment, including income as reported in past years. The ruling concludes that the investor generally can claim a theft loss deduction not only for the net amount invested, but also for the “fictitious income” that the promoter of the scheme credited to the investor’s account and on which the investor reported as income on his or her tax returns for years prior to discovery of the theft.

5. A theft loss deduction that creates a net operating loss for the taxpayer can be carried back and forward according to the timeframes prescribed by law to generate a refund of taxes paid in other taxable years.

6. Section B of Form 4684 is used to report the theft loss.

7. The safe-harbor revenue procedure is conditioned on taxpayers not amending prior years returns.

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.

1. The IRS will deem the loss to be the result of theft if: (1) the promoter was charged under state or federal law with the commission of fraud, embezzlement or a similar crime that would meet the definition of theft; or (2) the promoter was the subject of a state or federal criminal complaint alleging the commission of such a crime, and (3) either there was some evidence of an admission of guilt by the promoter or a trustee was appointed to freeze the assets of the scheme.

2. The discovery year is deemed to be the year in which an indictment, information, or criminal complaint is filed against the perpetrator.

3. Taxpayers are permitted to deduct in the year of discovery, 95 percent of their net investment less the amount of any actual recovery in the year of discovery and the amount of any recovery expected from private or other insurance, such as that provided by the Securities Investor Protection Corporation (SIPC). A special rule applies to investors who are suing persons other than the promoter. Investors suing third parties compute their deduction by substituting “75 percent” for “95 percent” in the formula above.

Investors should do their homework before they invest their money with anyone or any company. If you do find yourself a victim of a Ponzi scheme be sure to contact your attorney to ensure the right forms are prepared in order to obtain the maximum deductions.


For further information regarding these matters, please contact Mr. Jenney at 248.740.5688 or via email.

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