By LYNNLEY BROWNING
Published: March 17, 2009
The Internal Revenue Service said Tuesday that it would allow victims of Bernard L. Madoff’s huge investment fraud to claim a tax deduction related to the bulk of their losses.
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Douglas Shulman, the I.R.S. chief, said the Madoff case “raises a staggering array of tax issues.”
The plan represents the first time the I.R.S. has come forward with a policy on the treatment of Mr. Madoff’s victims, who include Elie Wiesel, the Holocaust survivor and Nobel laureate; Steven Spielberg, the filmmaker; and John Malkovich, the actor, among scores of other individuals, charities and universities.
The matter has been a point of debate and anxiety for the victims and their accountants, given the lack of clarity in the tax code about how it should be handled.
The plan, which applies to victims of all Ponzi schemes, is likely to provide major relief to victims of Mr. Madoff, who pleaded guilty last week to orchestrating what prosecutors say is the largest Ponzi scheme — one that exceeded $50 billion and involved 13,000 investors. It is also likely to provide clarity for victims as they prepare to file federal income tax returns by the April 15 deadline, and help the I.R.S. avoid an unwanted avalanche of amended returns from victims.
The commissioner of internal revenue, Douglas Shulman, announced the plan in testimony before a Senate Finance Committee hearing on Ponzi schemes, tax evasion and offshore banking fraud. Later, in a briefing, Mr. Shulman said that “clearly the Madoff case is tragic as so many people were victims of this fraud, but the case also raises a staggering array of tax issues.”
An I.R.S. official, who declined to be quoted by name under the rules of the briefing, would not say whether the deduction would apply to investors in the Stanford Financial Group, the Texas company accused by the Securities and Exchange Commission last month of orchestrating an $8 billion fraud. “To have a theft loss, there needs to be some evidence of criminal theft,” the official said, declining to comment further.
The I.R.S. plan eases rules governing theft losses, which are deductions claimed by investors who are cheated by their advisers and others in Ponzi schemes and similar frauds.
Under the plan, the I.R.S. will allow investors, including those who are suing Mr. Madoff, to claim a theft loss equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from the Securities Investor Protection Corporation, the government-chartered fund formed to help protect investors in failed brokerage firms. Investors who are suing third-parties involved in such a scheme, and who, as a result, may have some prospect of recovery, are permitted to claim a deduction equal to 75 percent of their investments.
The plan appears generous in that it allows investors to take a deduction against their total ordinary income on investment gains they were told they had received from Mr. Madoff but that turned out to be fictitious.
Current theft loss rules typically allow losses to be carried back three years and forward 20 years, but the I.R.S plan will allow carrybacks of as many as five years, generally if the loss is for a small business with gross annual receipts of less than $15 million. Under the plan, investors must claim the loss as having happened in 2008.
For people who invested with Mr. Madoff through retirement plans, like 401(k)s and individual retirement plans, the picture is more complicated because such money was already invested on a tax-free basis. Mr. Shulman, the commissioner, said that generally, if the investment was deductible when it was made, such investors “can’t take a loss.”
When computing losses, investors are not permitted to include any taxes they paid on what turned out to be fictitious income.
But the plan affords relief to such investors by allowing them to include fictitious income in their loss computations — a measure that might allow them to recoup taxes paid. It also will keep scammed investors from “owing taxes on income that they never received,” said Senator Charles E. Schumer, Democrat of New York and a member of the Senate Finance Committee.
People who invested with Mr. Madoff through so-called feeder funds that placed client money with him will also get relief. These funds will be allowed to claim the theft-loss deduction but will allot those losses proportionally to individual investors.
The I.R.S. said it did not know how much money in taxes investors had paid in recent years on Madoff-related income. It said that investors who had already filed 2008 returns should file amended returns claiming the theft-loss deduction.
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