2009-03-11 / Features

Crowley, Weiner Seek IRS Help For Ponzi Scam Victims


Citing the $50 billion Bernie Madoff Ponzi scheme, which bilked thousands of victims, as well as other reported similar scams, Congressmembers Joseph Crowley and Anthony Weiner have called upon the Internal Revenue Service to clarify the laws covering deductions for losses incurred and taxes paid on phantom gains.

In addition, the Queens lawmakers noted, there's the likelihood of other such schemes being uncovered with the ongoing shakeout of financial services firms on Wall Street which warrants clarification of federal tax laws for victims.

A good portion of the Crowley- Weiner appeal to the IRS dealt with "phantom income", profits listed on monthly or yearly statements, which in fact did not exist, but were taxed by the IRS.

Crowley declared, "With little regard for their victims, Ponzi scheme operators prey on clients' retirement funds, investments and life savings. The federal government is not only responsible for finding and prosecuting these scam artists, it must also let victims know their rights and how they can recoup the taxes they paid on phantom income."

Weiner noted, "For many victims the injury of the fraud has been compounded by the insult of having to pay taxes on the phantom gains."

In a letter to IRS Commissioner Douglas Shulman, Crowley, a member of the Ways and Means Committee with jurisdiction over the IRS, and Weiner, who's on the House Energy and Commerce Committee with jurisdiction over interstate commerce, zeroed in on the "theft loss" rule seeking clarification and the timeline for claiming.

The lawmakers noted that Section 165 of the Internal Revenue Code provides for deductions of losses, including losses from theft. But, they said, there was some uncertainty whether losses should be recorded under:

•Section 165 (c) (2) pertaining to losses incurred in a transaction for profit, or

•Section 165 (c) (3) pertaining to losses from theft.

They said this was important because if the losses are treated as having been incurred from transactions entered into for profit, there would be no casualty loss limitation imposed under Section 165 (h).

Additionally, they asked for specific guidance on taxpayer losses from the Bayou Group Ponzi scheme, which until recently had been the largest such fraud of this nature in American history. No further information on the Bayou scam was given.

The lawmakers also asked for clarification as to if such losses were to be determined by an investor's basis in the investment, including both invested principal and reported income not previously withdrawn, and if a taxpayer may carry-back these losses three years or forward 20 years.

As for the timeline for claiming under the theft loss rule, Weiner and Crowley noted: "Under Treasury regulations, a taxpayer may only claim a theft loss deduction after there is no reasonable chance of recovery of the funds."

This appears to mean, they pointed out, that taxpayers who may be interested in claiming the theft loss deduction must first apply for any reimbursement or insurance, such as a claim from the Securities Investment Protection Corporation (SIPC), before being able to claim this deduction.

If this is so, they asked, is it possible for taxpayers:

•to reduce the amount of loss by any potential claim and take the remaining loss currently? or

•to waive any claim for reimbursement in order to get closure and to ensure they can utilize losses against income?

The lawmakers also pointed out that if any of the perpetrator firms should seek to declare bankruptcy, it could take many years for a settlement, but the law only permits a three-year carry-back for losses from theft. This raises the question, they said, of whether the IRS stops the clock with respect to the three-year carry-back upon determination of the theft.

There is also a three-year limit, they noted, to file an amended tax return to recoup taxes that were paid on phantom returns, including capital gains or other income that never existed.

Because of the three-year limitation applying in these several cases, Crowley and Weiner requested that Shulman provide an explanation of the rationale behind limiting this carry-back to three years, and if there is precedence in the law or regulation for a taxpayer to seek redress for taxes incurred on phantom income dating back more than three years. For example, would the claim of right doctrine provide possible relief?

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