Can an Investment Become a Theft for Tax Purposes?

Bernie Madoff, like Charles Ponzi before him, ran a huge investment scam that cost many people billions of dollars. The IRS has a special rule for people who lost money in Ponzi schemes, allowing them to treat their losses as theft for tax purposes. This means they can deduct the losses from their taxes, but with limitations. For most people, they can only deduct up to $3,000 of their losses each year, and they might never get to use all of it. Simply put, federal income tax laws allow victims of fraud or theft to take a deduction for their losses. This deduction can be used against their regular income and can provide more immediate relief than a deduction for investment losses. The definition of “theft” is broad and includes criminal acts such as swindling and false pretenses. Whether a theft has occurred depends on the laws in the jurisdiction where the loss occurred. This means that victims of Ponzi schemes and other investment fraud can potentially claim their losses as theft for tax purposes. The record shows that Livingstone committed fraud to get money from people, which breaks Florida law and federal law. Even if the person committing the fraud isn’t charged with theft, it still counts as theft under the law. This can include things like swindling and securities fraud. For example, in another case, a company lied about its financial situation and tricked people into investing in it, which also counted as theft. The legal team determined that a theft took place, even though the transactions may have seemed different. They based their decision on a previous ruling where a person was tricked into lending money to a company by fake financial statements. In that case, the person was able to claim a theft deduction because the money was obtained through false statements. In Revenue Ruling 71-381 and Revenue Ruling 77-18, the IRS determined that theft occurred in certain situations involving Company X. In one case, false financial statements were used to convince stockholders to exchange their stock for Company X stock, which was worth less than represented. This was considered theft by false pretenses and qualified as a theft loss for tax purposes. In both cases, the IRS looked at the intent to defraud or misappropriate money and the reliance of the investors to determine if theft had occurred. In Vietzke v. Commissioner, the Tax Court ruled that the taxpayer could claim a “theft loss” for money invested in a company that turned out to be a scam. The company principals were charged with selling unregistered securities, and the court agreed that they intentionally swindled the taxpayer. The court didn’t rely on the specific crimes the principals were charged with, but instead focused on the fact that they intended to cheat the investor. Ultimately, the taxpayer was allowed to claim a theft loss for the money he lost. In a court case, the IRS agreed that a broker’s unauthorized trading in a taxpayer’s brokerage account was considered “theft” under the law. The taxpayer, a carpet installer, had invested money with a brokerage firm, but the broker made false claims and made unauthorized transactions in the account. Even though the court agreed it was theft, the taxpayer couldn’t claim a “theft loss” deduction because he was still trying to sue the brokerage firm involved. In another case, the IRS was prevented from denying a theft occurred in a taxpayer’s investment because the government had successfully prosecuted the people involved in a criminal case.

The IRS also has a “safe harbor” rule for treating certain investment losses, such as those from Ponzi schemes, as theft losses. If a taxpayer has invested in a fraudulent scheme and the perpetrator has been charged with a crime that meets the definition of “theft,” the IRS will consider it a theft loss. To use the safe harbor for claiming a theft loss on taxes, a person must have invested in a Ponzi scheme and the person or people who ran the scheme must have been charged with a crime like theft. If the charges are by complaint instead of indictment or information, then one of three other factors must also be present. The person claiming the loss must not have known about the fraud before it became public, and the safe harbor doesn’t apply to people who invested through a fund or other entity. If someone steals your stuff, you can only deduct the loss on your taxes in the year you find out about it. If there’s a chance you might get your stuff back, you can’t deduct the loss until you know for sure that you won’t get it back. This has caused a lot of arguments in court because it depends on the specific details of each case. For victims of Ponzi schemes who choose the safe harbor provisions of Revenue Procedure 2009-20, the timing of the deduction for their losses is made clear. The year they discover the loss is the year they can deduct the amount they lost. The amount they can deduct is determined by applying a fixed percentage to the amount they invested in the fraudulent scheme. If they are not trying to recover money from others, they can deduct 95% of their investment. If they are trying to recover money, they can deduct 75%. After deducting any actual recovery or insurance payments, the remaining amount can be deducted from their taxes. If they later recover more money than they deducted, they have to include the excess in their income. They can also deduct any additional losses in a later year, if they are sure they won’t be able to recover that money. This makes it easier for them to claim their theft loss on their taxes.
Investment fraud can have serious consequences, causing people to lose their life savings and struggle to pay bills. The IRS has a special process for victims of investment fraud to claim a deduction for their losses. However, most situations don’t qualify for this special treatment, so it’s important for victims to carefully support their deduction. It’s important for investors who have suffered a theft loss to make sure they follow the rules to claim the deduction and get the relief they deserve. If you are the victim of theft or fraud, you may be able to deduct the loss on your taxes. This is true even if the theft is connected to a business investment. You have to show that you suffered a loss and there is no chance of getting the money back. The rules for when you can claim the deduction can be complicated, and you might need to consult a tax professional for help. Investors who have been defrauded may be able to get some of their money back through tax deductions. There are certain sources of recovery that are excluded from this, but investors can still deduct most of their investment losses. If investors included fake income from the fraud in their taxes, they can also increase their tax deductions. Jeffrey P. Coleman and Jennifer Newsom, who are lawyers, help investors with securities and investment fraud cases. We want our members to learn about their responsibilities and serving the community, making the justice system better, and advancing the study of law.

Source: https://www.floridabar.org/the-florida-bar-journal/can-an-investment-become-a-theft-for-tax-purposes/