IRS issues guidelines to assist Madoff victims

Victims of Bernard L. Madoff's massive Ponzi scheme will be able to deduct up to 95 percent of their investment loss, IRS Commissioner Douglas H. Shulman said Tuesday before the Senate Finance Committee.

The IRS is issuing guidelines that would cover victims of all Ponzi schemes, not just Madoff's, and would ease the rules for claiming theft-loss deductions, which are losses claimed by victims of fraud. Classifying the losses as theft losses rather than capital losses gives victims a much larger deduction, Bloomberg News reported.

The IRS plan allows investors to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains, and payouts from the Securities Investor Protection Corporation. Those who are suing third parties involved in the Ponzi scheme, and therefore have hope of recovering some of their losses, can claim a deduction equal to 75 percent of their investments. Under the plan, investors must claim the loss as having happened in 2008.

The IRS will also provide a "safe harbor" that allows Madoff victims to claim a theft loss deduction now, even if there is a chance they could recover some of their investment loss later.

Madoff pleaded guilty last week to leading what may be the largest Ponzi scheme ever, at an estimated $65 billion. He was sent to jail, pending his sentencing June 16.

Finance Committee member Charles Schumer (D-NY) said the plan will prevent scammed investors from "owing taxes on income that they never received," The New York Times reported. In an e-mail to the New York Daily News he wrote, "The IRS has done the right thing here. In most every area where there was dispute, they have sided with the victims."

In his testimony, Shulman said, "Some taxpayers have argued that they should be permitted to amend tax returns for years prior to the discovery of the theft to exclude the phantom income and receive a refund of tax in those years. The revenue ruling does not address this argument, and the safe-harbor revenue procedure is conditioned on taxpayers not amending prior year returns."

You can read Shulman's testimony and links to the specific guidance.

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