Bipartisan Senate
legislation would
provide tax relief
to investors
victimized by
securities fraud in
Ponzi scheme types
of operations. Since
the legislation
applies only to
qualified fraudulent
investment losses
discovered in
calendar years 2008
or 2009, it
essentially assists
victims of frauds
such as those run by
disgraced financiers
Bernard Madoff and
Allen Stanford. The
measure would extend
certain benefits
that are already
available to larger
investors to smaller
investors as well.
It would allow
victims to take a
deduction for funds
lost from their IRA
accounts, allow for
accelerated and
increased
contributions to
tax-free retirement
accounts to make up
for losses and allow
for penalty-free
early withdrawals
from retirement
accounts for
investors in dire
need of cash.
The
Ponzi Victims Tax
Bill of Rights,
S.3166, was
introduced by
Senator Charles
Schumer (D-NY) and
has picked up strong
bi-partisan support,
including that of
Senate Banking
Committee Chair
Christopher Dodd
(D-CT). Senator John
Kyl (R-AZ) is a key
Republican sponsor.
The
IRS originally
issued rules in
March 2009 allowing
direct investors to
take a theft loss
deduction for their
Ponzi scheme losses.
The rule said that
theft losses could
be treated as net
operating losses (“NOLs”),
as if the individual
investors were small
businesses. Direct
investors were
allowed to carry
back their losses
for five years
instead of three,
and carry forward
any remaining losses
for up to 20 years.
A longer carry back
is important because
it provides refunds
for taxes paid in
past year.
However, even with
the NOL relief
afforded to
thousands of
victims, a number of
tax problems remain
unaddressed. In
order to expand
relief available to
Madoff’s smaller
investors, the
Schumer-Kyl
legislation would
increase the amount
victimized investors
can carry back on
their income taxes,
allow victims who
lost money within an
IRA to recoup some
of the losses for
the first time by
allowing a theft
loss for their basis
in the account or
half their total
losses, raise the
limit on tax-free
contributions to
retirement accounts
so investors can
replenish losses
quicker and waive
penalties for
withdrawing from
retirement accounts
to increase daily
cash flow.
The
measure would define
a qualified
fraudulent
investment loss
based on the March
2009 IRS guidance.
It would allow both
direct and indirect
investors with
qualified fraudulent
investment losses to
carry back eligible
losses to up to six
prior taxable years,
which doubles the
period that existed
prior to March 2009.
The same rules with
respect to NOL carry
backs of qualified
fraudulent
investment losses
would apply to both
direct and indirect
investors. For all
of the provisions of
S.3166, the amount
of any qualified
fraudulent
investment loss is
reduced by any
expected recovery
through the
Securities Investor
Protection
Corporation or legal
action.
Many
victims,
particularly a
number of the
smaller investors,
held Ponzi-related
assets in an IRA.
Under current law,
no tax relief is
available for losses
resulting from the
theft of assets held
in an IRA. An
individual who lost
a $250,000
investment in a
taxable account as a
result of the Ponzi-scheme
theft received a
deduction for the
loss, but an
individual who lost
a $500,000
investment in an IRA
received no relief.
Taxes
have not been paid
on the majority of
retirement savings
since they are
funded with pre-tax
money, so the amount
of the allowable tax
loss must be
adjusted. Under the
bill, victims will
be allowed to claim
a loss deduction for
the qualified
fraudulent
investment loss in
an IRA in an amount
equal to the greater
of 100% of their
individual and
employer
contributions or 50%
of the IRA theft
loss. The maximum
loss that may be
claimed under this
provision is $1.5
million. Under the
legislation, the IRA
loss deduction may
be carried back for
up to six taxable
years and carried
forward for up to 20
years. For IRAs that
contain money rolled
over from other
retirement accounts,
the amount of the
rollover is not
considered to be an
employee
contribution.
Instead, an
individual must
substantiate the
portion of the
rollover that is
attributable to
employee and
employer
contributions.
For
any eligible
individual who
turned 65 by
December 31 of the
year that the theft
was discovered, the
bill increases the
maximum NOL carry
back period for
qualified fraudulent
investment losses to
seven years. The
legislation would
allow a waiver of
the 10% tax penalty
for withdrawals from
retirement plans for
an individual who is
under age 59�
and who suffered a
loss related to the
Ponzi scheme.
Penalty-free
withdrawals would be
permitted for up to
10 years from the
date of the
discovery of the
fraud, or until a
taxpayer has
withdrawn the amount
of the loss,
whichever comes
first. An individual
would still be
required to pay
income taxes on the
withdrawn funds
since the measure
would simply waive
the 10% penalty on
early withdrawals in
these circumstances.
To
help restore an
individual’s IRA
savings in the event
of a qualified
fraudulent
investment loss, the
bill includes a
special catch-up
contribution
provision which
allows an individual
to contribute up to
an additional 100%
of the current
contribution limits
to any IRA account
for a period of up
to 10 years. This
special catch-up
contribution will be
available for any
individual who owns
an IRA that lost at
least 50% of its
value as a result of
a qualified
fraudulent
investment loss. For
an individual with
multiple IRAs, the
bill allows the
catch-up
contribution for
each eligible IRA.
Many
victims filed estate
or gift tax returns
reporting
investments in
Ponzi-scheme assets
which overstated the
value of these
assets. The measure
would allow a period
of time to file
amended estate and
gift tax returns to
obtain a refund of
transfer taxes paid
or to adjust the
lifetime gift tax or
generation skipping
transfer tax
exemptions to
reflect the lower
value of the assets
transferred. The
effect of the bill
will be to permit
certain estate or
gift taxes paid on
Ponzi-scheme assets,
or lifetime gift tax
or generation
skipping tax
exemptions that have
been used with
respect to
Ponzi-scheme assets
to be appropriately
refunded or
restored.
The
bill would also
allow an individual
to amend returns, as
necessary, for
reportable gifts
made in the year the
theft is discovered,
and the six taxable
years prior to the
theft discovery. An
individual would
have up to four
taxable years after
the discovery of the
fraud to amend his
gift tax returns.
For example, a
victim of the Madoff
Ponzi scheme will
have until December
31, 2012 to file
amended gift tax
returns for gifts
made in tax years
beginning January 1,
2002 and subsequent
years through the
date of discovery of
the theft.
For
estate taxes, the
measure would allow
estate tax returns
for decedents who
die after December
31, 2007 to be
amended to account
for Ponzi scheme
assets. For
decedents who died
before January 1,
2008, consistent
with present law,
beneficiaries who
inherited assets
that became
worthless after
inheritance as a
result of a Ponzi
scheme would be able
to use the NOL
treatment and other
benefits afforded to
all victims.