IRS To Allow Tax Relief for Madoff Victims

By Jeralyn, Section Crime in the News
Posted on Tue Mar 17, 2009 at 11:24:37 AM EST
Tags: Bernard Madoff (all tags)

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The I.R.S. announced today that victims of Bernie Madoff's ponzi scheme will be entitled to tax refunds if they paid taxes on phantom profits.

Madoff investors should have been reporting earnings from their investments with him through the years and thus paid taxes on those earnings. Given that some of those were "phantom" profits, investors have said they should be entitled to refunds of the taxes they paid.

....By some estimates, the IRS could be out as much as $17 billion in lost tax revenue from refunds to investors who earned fictitious profits in the Madoff scheme.

IRS Commmission Douglas Shulman told Congress today the IRS will be issuing guidelines to Madoff's bilked investors: [More...]

Under the plan, which has been reviewed by the congressional offices, the I.R.S. will allow investors who are not suing Mr. Madoff to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from Securities Investor Protection Corporation, the government-chartered fund set up to help protect investors of failed brokerage firms.

Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.

In other Madoff news, it looks like creditors seeking Ruth Madoff's $9 million Palm Beach home may be out of luck. She filed for and obtained a homestead exemption on it. Remember when O.J. moved to Florida and why?

"The Florida Constitution provides that a civil creditor cannot force the sale of a person's homestead to collect a civil judgment," Jonathan Alper, an Orlando attorney who edits a Florida blog, told the Post. "There is no dollar limitation so that homestead properties are exempt from forced sale by creditors regardless of how much money the debtor invests in his homestead."

But one news report says the house would have to be her primary residence and could not have been obtained with illegal proceeds from Bernie's scam.

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IRS To Allow Tax Relief for Madoff Victims | 13 comments (13 topical)

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I don't have a problem (5.00 / 1) (#1)
by Bemused on Tue Mar 17, 2009 at 11:32:16 AM EST

with the allowances decribed , but does this apply only to Madoff investors or to anyone who has paid taxes on phantom profits as a result of being defrauded?

I'm also not sure that providing an incentive for people not to sue Madoff (20%) is a good idea. Why not have the same allowance and then provide for the IRS to recoup taxes if any of the litigants make a recovery?

: Investors in some of these cases are entitled to a (none / 0) (#3)
by sarcastic unnamed one on Tue Mar 17, 2009 at 11:49:52 AM EST

Investors in some of these cases are entitled to a "theft loss" deduction, not subject to the limits on normal capital losses from investments, according to the IRS guidelines, Shulman testified at a Senate Finance Committee hearing.
The theft loss deduction can be taken in the year a fraud is discovered, except to the extent an investor has a reasonable prospect of recovery of the lost money, Shulman said.

How about the victims... (none / 0) (#2)
by kdog on Tue Mar 17, 2009 at 11:41:18 AM EST

of fraud at the hands of the US govt...do we get similar tax relief? At the least we should be allowed to deduct our share of the various corporate handouts, as well as our share of the Iraq fraud....sh*t our share of the drug war fraud too. Help me out..what other frauds am I forgetting?

Are there likely to be victims who aren't suing? (none / 0) (#4)
by steintr on Tue Mar 17, 2009 at 12:54:55 PM EST

Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.

Given the inevitable class action suits, does this mean that the IRS actually expects people to decide to opt-out to claim the higher deduction? If so, that could be an interesting test of confidence in the class litigation strategy. (Ordinarily, one only has to bother opting out if you want to sue on your own, but here one would want to do so if you thought the claims would ultimately be unsuccesful as well.)

In these situations (5.00 / 0) (#5)
by Steve M on Tue Mar 17, 2009 at 02:23:31 PM EST

I'm not sure I would expect people to even know if they're potential class members in a class-action lawsuit, since notice to the class doesn't typically happen until a much later stage.

I'm frankly not certain why the issue of litigation even enters into it, because it's a virtual certainty that no one will be recovering their lost profits as a result of litigation. At best, all they can hope for is to have some of their principal returned, and return of principal is not taxable.


I'm actually unclear how anyone who had money (none / 0) (#6)
by sarcastic unnamed one on Tue Mar 17, 2009 at 02:46:33 PM EST

with Madoff got taxed.

"Profits," which I assume in this case are primarily capital gains, are taxed when they're taken, ie., when you take your investment + "profit" out of the fund.

So if you never took your money + gains out of his fund, you were never taxed, right?

And if you did take your investment + gains out of the fund, then you had actual gain/profits and should pay tax on them.

I must be missing something...


I don't think so (5.00 / 0) (#7)
by Steve M on Tue Mar 17, 2009 at 02:58:13 PM EST

Unless your mutual fund is tax-exempt, or it's held within a tax-exempt retirement plan, I believe you have to pay taxes on the fund's short-term capital gains each year whether or not you take a distribution. This is a difference between holding shares of a mutual fund and holding individual shares of stock, where of course you don't pay tax until you cash in.


: OK, that makes sense. (none / 0) (#8)
by sarcastic unnamed one on Tue Mar 17, 2009 at 03:22:26 PM EST

: Capital gains tax (none / 0) (#12)
by steintr on Wed Mar 18, 2009 at 01:02:43 AM EST

So leaving aside for the moment the possibility that the trustee will ultimately claw back gains that were withdrawn from the fund, if it turns out that what you thought were capital gains were in fact ordinary income from a Ponzi scheme (because there were never any actual securities bought or sold), do you really owe more tax? :)

OK (none / 0) (#9)
by squeaky on Tue Mar 17, 2009 at 03:39:57 PM EST

And if they were not paying taxes they have to pay back plus interest and penalty?

I bet that there is a class of Madoff investors that do not want the books looked at too closely.

Hm (none / 0) (#10)
by Steve M on Tue Mar 17, 2009 at 03:46:42 PM EST

Not paying taxes on your mutual fund investments is kinda similar to not paying taxes on the interest income from your bank. The IRS gets a copy of that tax form you receive at the end of the year. Your chances of getting away with not reporting that income seem rather small.


: And (none / 0) (#11)
by squeaky on Tue Mar 17, 2009 at 03:55:26 PM EST

I am sure that those whose money was not taxed at all before investing with Madoff are not thinking about their 1099's.

Homestead Exemption My Patootie (none / 0) (#13)
by Amiss on Wed Mar 18, 2009 at 01:27:54 AM EST

the house would have to be her primary residence and could not have been obtained with illegal proceeds from Bernie's scam.

She has not spent one day of 2009 in that home, I believe she is going to be hard pressed to prove that is her primary residence. And you do not get to reap the rewards of a homestead exemption in Florida until the year AFTER it was filed. IOW she has to have actually lived in the house for 2009 to actually TAKE the exemption in 2010.