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Ponzi Schemes And The Theft Loss Deduction

Every few months or so seem to bring new revelations of a Ponzi scheme gone bust.[1] In the aftermath, erstwhile investors often struggle to be made whole again. Fortunately, the federal income tax offers options to help, although none are perfect.

Under the federal income tax, individuals currently have two ways to claim a deduction for losses due to Ponzi schemes: 1) follow the general rules for deducting theft losses under I.R.C. § 165 (which can be unduly burdensome), or 2) follow the “safe-harbor” under Revenue Procedure 2009-20 (which sets limitations on the deductible amounts of such losses).

I.RC. § 165, Generally

I.R.C. § 165 generally allows individuals to deduct losses not otherwise compensated for that are sustained during the taxable year in any transaction entered into for profit.[i] See I.R.C. § 165(a), (c)(2). This includes losses due to theft. See Treas. Reg. § 1.165-8(a)(1).

Written by TaxConnections Admin | Posted in Freeman Law • Ponzi Schemes • Theft Loss Deduction

Recent Tax Court Case And Theft-Loss Deductions

A recent Tax Court case dealt with a familiar topic: Theft losses. I.R.C. section 165 has historically allowed taxpayers to deduct three types of losses: those incurred in a trade or business, those incurred in a transaction entered into for profit, or losses arising from other causes, such as theft. (Note, however, that due to certain changes pursuant to the Tax Cuts & Jobs Act of 2017, individuals may be prevented from taking certain theft losses.)

A theft for these purposes is defined broadly, and encompasses various criminal conduct, including larceny, embezzlement, and robbery. Treas Regs. Sec. 1.165-8 (d). A taxpayer must prove that the theft occurred under the law of the jurisdiction where the alleged loss occurred, See Monteleone v. Commissioner, 34 T.C. 688 , 692 (1960), the amount of loss, and the date that the loss was discovered. Taxpayers who can establish these element may be entitled to deduct a theft loss. (Again, the TCJA may limit a taxpayer’s ability to deduct a theft loss.

Below is a summary of the Tax Court’s recent decision:

Written by Fernando Juarez | Posted in IRC Sec 165 • Theft Loss Deduction