When the Bernie Madoff saga became front page news, lots of those who had invested bemoaned their losses. And certainly there were lots of losses in the multi-billion dollar ponzi scheme. But as the federal prosecutors' work proceeds, some interesting information--with new tax angles to be considered--has appeared.
It turns out that the government's search of financial records going back to 1979 "shows that investors suffered net losses exceeding $13 billion." At the same time, "about half of the customers had not lost money because they withdrew more money than they originally invested." AP, Review Says No Net Loss for Some in Scheme, NY Times (Sept. 23, 2009).
Let's consider those investors who "got back more than they originally invested." The IRS guidelines permitted Madoff victims to claim 95% of their theft losses--their original investment plus the phantom profits that they paid taxes on minus the SIPC recovery and any other recovery-- for 2008 (in the year of the discovery of the scheme) on the assumption that they wouldn't have much "reasonable prospect" of recovering the lost amounts. The rest would be claimed over time. See Kerber, New IRS Rules Offer Relief to Madoff Investors, Boston Globe (Mar. 18, 2009). The losses could be claimed based on the information about initial investments. These rules were more favorable than the IRS's former position on reporting ponzi scheme losses, which required taxpayers to wait--often years-- until they had more information about their actual loss. See Novack, Madoff Victims Get Immediate Tax Relief, Forbes (Mar. 17, 2009) (noting that "the IRS was under considerable pressure to relax those rules," even though they had been upheld in court, after the Madoff scheme came to light).
So if members of this group of about half the victims claimed losses on their 2008 returns but, it turns out, didn't actually have any loss of their original investment (and in fact had at least some real profits among those profits that they paid capital gains-rate taxes on), perhaps they should amend their returns?... After all, many of those who had already amended their returns to get rid of the phantom income and thus get a refund of the capital-gains-rate taxes paid apparently re-amended their returns to report the income and leave the taxes paid (at capital gains rates) so that they could take advantage of the IRS change of heart about the ability to claim immediate losses in the year the ponzi scheme is discovered for invested amounts and phantom income on which taxes had been paid, reporting the investment theft loss and getting ordinary losses that carry back 3 (or 5) and forward 20 years. See Tax Girl, Madoff Victims Get a Break (or the one where I say things that get people mad) (Mar. 24, 2009).
(As to taxes paid on what actually turn out to be phantom gains, I still think the rule should be that you could claim a refund of taxes that you had actually paid at capital gains rate on that fictional income, rather than getting to claim an ordinary loss for the fictional income amount on which you paid taxes, since the latter ultimately means you get back at ordinary rates while having paid in at capital gains (lower) rates and should violate the tax benefit doctrine. Especially when your loss claim is expedited to be allowed even before you know whether you have one or not.....)
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