As more Ponzi schemes are unearthed and thousands of victims discovered across Queens, New York City and the United States, Congressmen Joseph Crowley (D-Queens, the Bronx) and Anthony Weiner (D-Brooklyn, Queens) called on the Internal Revenue Service (IRS) to clarify regulations on payments made on “phantom income” in order to help victims recover their assets.
“Victims of Ponzi schemes are not only limited to Madoff-level investors. Just last month, the FBI raided a Queens-based Ponzi operator who had bilked local investors of more than an estimated $380 million,” said Congressman Crowley.
“With little regard for their victims, Ponzi scheme operators like Bernie Madoff 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. Congressman Weiner and I believe the time has come for the IRS to clarify its laws and help the victims of these crimes more easily recover their assets.”
Rep. Weiner said, “For many victims, the injury of the fraud has been compounded by the insult of having to pay taxes on the phantom gains.”
Congressmen Crowley and Weiner sent a letter on February 27, 2009 to IRS Commissioner Douglas Shulman requesting clarification of the Federal tax laws governing taxes paid on phantom income as well as losses incurred by the victims of various Ponzi schemes. The full text of the Crowley-Weiner letter is included below.
Congressman Crowley is a member of the exclusive House Committee Ways and Means with jurisdiction over the IRS; Congressman Weiner is a member of the House Energy and Commerce Committee, with jurisdiction over interstate commerce.
February 27, 2009
The Honorable Douglas Shulman
Commissioner of Internal Revenue
Internal Revenue Service
1111 Constitution Avenue, NW
Washington DC 20224
Dear Commissioner Shulman:
The news of the Madoff Ponzi scheme, which reportedly totaled $50 billion, as well as the Bayou scheme and another major Ponzi scheme in Queens, New York, has brought a few tax-related issues to the forefront.
Considering the likelihood of additional fraud cases being uncovered due to the increased attention and regulation of the financial sector and the increasing redemptions occurring on Wall Street, we respectfully request clarification of the Federal tax laws governing taxes paid on phantom income as well as losses incurred by the victims of various Ponzi schemes.
Theft Loss Rule – Clarification of the Designation
As we understand, section 165 of the Code provides for deductions of losses, including losses from theft. Taxpayers affected by the growing number of Ponzi schemes have expressed some uncertainty regarding whether their 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.
This is an important determination because if the losses are treated as having been incurred from transactions entered into for profit, there would be no casualty loss limitations imposed under section 165(h).
While we understand the IRS will not – nor should it – comment on issues specific to individual taxpayers or cases, we do seek overall guidance from your agency on the criteria used in determining how to classify these losses from Ponzi schemes. Clarification of this question by the IRS is important as the victims of these schemes are looking for relief.
Additionally, we seek guidance from the IRS on the criteria used in determining the classification of taxpayer losses in the Bayou Group Ponzi scheme, which until recently was the largest such fraud of this nature in American history.
Finally, we ask that you clarify that such losses 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 and may carry forward the losses 20 years. This would allow the victims some ability to recover taxes on erroneously reported income, as well as some portion of their lost principal.
Theft Loss Rule -- Timeline for Claiming
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 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 Investor Protection Corporation (SIPC), before being able to claim this deduction.
Is it possible for taxpayers (i) to reduce the amount of loss by any potential claim and take the remaining loss currently, or (ii) to waive any claim for reimbursement in order to get closure and to ensure they can utilize losses against income?
Additionally, as the process of unwinding the finances or filing of bankruptcy protections by the perpetrators of these frauds could add months – and likely even years – to any resolution of the question of reasonable chance of recovery, but the law only permits a three year carry back for losses from theft, it raises the question of whether the IRS stops the clock with respect to the three carry back upon determination of the theft.
There is concern that it will take many years, especially in the most complex cases, before any official determination can be made as to whether there is any chance of recoupment of funds for those victims of theft. This multi-year delay could rob these taxpayers of their ability to claim their rightful deduction under theft loss rules.
Taxes Paid on Capital Gains and Other Phantom Income
The law allows a taxpayer to file an amended Federal tax return dating back three years to take into account any taxes paid on any phantom gains, including capital gains or other income that never really existed.
We have been asked about the fairness of this three year limitation as there are many defrauded investors who had investments dating back more than three years, and who paid taxes on income that never existed. So we request that you provide explanation of the rationale behind limiting this carry back to three years, and if there is precedence in 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?
We appreciate your attention to this matter and look forward to working with you on this matter. Thank you.
Joseph Crowley, Member of Congress
Anthony D. Weiner, Member of Congress