Mangled by Madoff? The IRS Offers Tax Tips for Reporting Those Losses

Now, in Revenue Procedure 2009-9, the Internal Revenue Service has outlined the proper income tax treatment for losses resulting from these Ponzi schemes, while Revenue Procedure 2009-20 provides an optional safe harbor method for eligible taxpayers to deduct theft losses from criminally fraudulent investment arrangements that take the form of “Ponzi” schemes.   “The safe harbor method provides a uniform, simplified method for eligible taxpayers to determine the amount and timing of their theft loss deductions,” according to the IRS.

In releasing the guidance, the IRS notes that both that agency and the Treasury Department recognize that “…whether and when investors meet the requirements for claiming a theft loss for an investment in a Ponzi scheme are highly factual determinations that often cannot be made by taxpayers with certainty in the year the loss is discovered.”   Consequently, and “in view of the number of investment arrangements recently discovered to be fraudulent and the extent of the potential losses”, the revenue procedure provides what the IRS described as an optional safe harbor under which qualified investors (as defined in § 4.03 of this revenue procedure) may treat a loss as a theft loss deduction when certain conditions are met.   The IRS notes that this treatment “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.”

The Revenue Procedure is available online at http://www.irs.gov/pub/irs-drop/rp-09-20.pdf

Revenue Ruling 2009-09 addresses the tax treatment of losses from criminally fraudulent investment arrangements that take the form of “Ponzi” schemes.   The ruling holds that the losses are theft losses and provides guidance on the character, timing, and amount of the loss deduction through a series of sample situations.   That information is available online at http://www.irs.gov/pub/irs-drop/rr-09-09.pdf

Revenue Procedure 2009-20 and Revenue Ruling 2009-09 will be published in Internal Revenue Bulletin 2009-14 on   April 6, 2009.