H.R. 1159: Tax Relief for Theft-Loss Victims

Meek Statement Regarding the Similiarities of the IRS Ponzi Scheme Published Guidance and Meek Bill, H.R. 1159

I have filed H.R. 1159, a bill to amend the Internal Revenue Code to provide tax relief to victims who have been harmed in fraudulent Ponzi-type schemes. H.R. 1159 provides relief to investors harmed by Ponzi schemes to ensure they can properly take their losses and recoup taxes paid on “phantom” income reported in earlier years. The majority of these investors are retirees—many of whom are elderly—and they may not have sufficient income in subsequent years to use their losses.

The IRS has recently issued guidance to assist taxpayers who are victims of losses from these Ponzi-type investment schemes. I am pleased that the IRS has taken a position that provides clarity to the victims of these fraudulent schemes which is similar to the provisions for relief in my bill.

While the IRS went as far as possible under current law, only through legislation can further appropriate relief be provided to these victims, especially our seniors and retirees, many of whom had been investors in the Ponzi schemes for ten to twenty-five years. 

I would like to outline for you the provisions in the IRS-issued guidance that complement my bill, H.R. 1159, beginning with the provision in my bill that helps our seniors.

Carryback Period

H.R. 1159 extends the carryback period to up to ten years

Under Section 172 of the Internal Revenue Code, losses as a result of theft are eligible to be carried back to the three taxable years preceding the loss, or the taxpayer may carry it forward to each of the 20 years following the loss year. H.R. 1159 extends the carryback period for theft losses arising from fraudulent Ponzi-type schemes to up to ten years. This important provision of H.R. 1159 helps the seniors and retirees.

IRS Guidance extends the carryback period to 5 years (with 2 conditions)

The IRS guidance extends the carryback period to 5 years for 2008 if an individual has gross receipts of less than $15 million. This extension to only five years (and the 2008 and gross receipt limitation) was as far as the IRS could extend the carryback period under current law. However, the five year carryback is clearly a step in the direction of my bill. To extend the carryback period further, legislation is necessary.

While this effort on the part of the IRS is appreciated, the five year carryback period does not provide sufficient relief to allow victims to recoup taxes on fictitious income over many years, in particular, our Senior citizens. In addition, it is limited to those individuals who have gross receipts of less than $15 million. It is also limited to the 2008 taxable year. While the 2008 year helps the victims of the Madoff scandal, it does not help the victims of the recent 2009 Ponzi schemes, or victims in the future.

A lot of our seniors lost their retirement savings in these fraudulent schemes, and we need to make sure our seniors get our help. The 10 year carryback provision in H.R. 1159 would provide a remedy so that the investor-victims would be able to offset income that they previously reported as income over a period of years. Extending the carryback period to ten years is essential to our seniors and retirees - because a lot of the Ponzi-scheme investors are elderly, there is a need to let these taxpayers offset against previously earned income.

Our seniors would not get a benefit to carrying the loss forward 20 years as most are retirees—they are not going to get an income in the next 20 years. Most taxpayers retire around age 60. Therefore, a 70 year old investor who lost money in a Ponzi scheme would need a 10 year carryback to offset the losses against a time when he/she was working and earning income, i.e., age 60 to 65.

Many of these defrauded seniors are not wealthy—they live on fixed incomes, have lost their nestggs and now face an uncertain future. They are liquidating assets, selling real estate, and returning to work in the midst of an economic recession. Therefore, the ten year carryback period would help our seniors meet their future needs.

For example, a taxpayer who is in his 60’s and retired puts $100 into a Ponzi scheme. The taxpayer is in the Ponzi scheme for the last 5 years. The taxpayer supposedly received $10 per year in income for each of the 5 years and withdrew nothing. Now the taxpayer finds out the investment is worthless. The taxpayer has lost his $100 initial investment. He has also reported and paid tax on $50 of illusory income over the 5 years. H.R. 1159 bill would allow the taxpayer to go back 10 years to take the loss over 10 years, and allow the taxpayer to be able to offset income that they previously reported as income over a period of years.

Prospect of Recovery

Current Law:

Under Section 165 of the Internal Revenue Code, losses from theft are treated as sustained in the taxable year in which the taxpayer discovers the loss. However, taxpayers may not deduct losses if they have a claim for reimbursement until there is no reasonable prospect of recovery on the claim. In other words, the taxpayer has to wait until the possibility of recovery has lapsed.

My Bill H.R. 1159:

Under my bill, a victim would be allowed to claim loss on a “fraudulent Ponzi-type scheme” in the taxable year in which such theft loss is discovered and can reasonably be estimated, even if they have a potential claim for reimbursement. Any subsequent reimbursement would be included in income, to the extent a loss deduction had previously been taken.

This provision would especially help the elderly who have lost money. First, in the Madoff situation, it is unlikely there will be any money for reimbursement. Second, even if money is found in the future, the elderly investors need cash now – they are retired and not working.

IRS-Issued Guidance:

Under the IRS-issued guidance, the theft loss is deductible in the year the fraud is discovered, except to the extent there is a claim with a reasonable prospect of recovery.  However, the IRS has provided a safe-harbor approach that the IRS will accept for reporting Ponzi-type losses.

This is clearly in the direction of my bill. However, this safe-harbor differs from H.R. 1159 in two respects:

1. The safe harbor permits the taxpayer to deduct in the year of discovery only 95% of their net investment less the amount of any actual recovery in the year of discovery and the amount of any recovery expected for private or other insurance. H.R. 1159 provides that 100% may be deducted.
2. However, the more importance difference is that that the safe-harbor revenue procedure is conditioned on taxpayers not amending prior year returns. H.R. 1159 leaves the option open to some taxpayers who will want to amend their prior year returns as permitted under current law.

Limits on Deductions

Current Law:

Section 165 of the Internal Revenue Code allows taxpayers to deduct losses sustained during a taxable year that are not compensated by insurance. In the case of individuals, casualty and theft losses are fully deductible if they are incurred in a trade or business, or are incurred in a transaction engaged in for profit. If casualty and theft losses do not arise in connection with a trade or business or a transaction engaged in for profit, such losses are deductible only to the extent they exceed $100 (per occurrence) and 10% of the taxpayer’s adjusted gross income, in aggregate.

My Bill H.R. 1159:

My bill clarifies that theft losses arising from fraudulent Ponzi-type schemes are from transactions “engaged in for profit” and thus are not subject to the $100 or 10% AGI limitation.

The Madoff victims seemingly should not be subject to these limits because the theft losses were in incurred in transactions “engaged in for profit.”

IRS Guidance:

The IRS guidance clarified this exactly like my bill: investment theft losses are not subject to limitations that are applicable to personal casualty and theft losses. The loss is deductible as an itemized deduction, but is not subject to the 10 % of adjusted gross income reduction or the $100 reduction that applies to many casualty and theft loss deductions.