Skip to main content

Ponzi Schemes and Taxes (Losses)

Many of our clients have been requesting information on Ponzi schemes and tax losses, as unfortunately there have been many recent pyramid/Ponzi schemes in the news lately (even after Bernie Madoff has been sentenced for the multi-billion dollar losses). If you have been the victim of any recent pyramid scheme (whereby investment “returns" are paid by new people joining the scheme and not by any actual investment returns), a very favorable IRS ruling (Revenue Ruling 2009-9) and procedure (Revenue Procedure 2009-20) should be immediately obtained (at www.irs.gov). These provisions apply to losses only for 2008 and future years and cannot be used for losses discovered in 2007 and earlier years. Here are the basic rules for dealing with these schemes from a tax perspective:

  1. Any losses incurred in these schemes are treated as theft losses and not capital losses. This is favorable because a theft loss is not limited in any given year, while a capital loss is capped at $3,000 per year.

  2. The IRS is also waiving the phase out on other theft losses. In general, a theft loss is deductible as an itemized tax deduction on Schedule A but is limited to the amount lost, less any actual amounts recovered, reduced by 10% of your Adjusted Gross income (i.e. if your AGI was $100,000, the theft loss would be reduced by 10% of this amount, or $10,000). This reduction does not apply to these pyramid scheme losses in that the IRS is treating these losses as entered into for profit and not subject to the reductions.

  3. The loss is deductible in the year it is discovered as long as the loss is not reimbursed or subject to a claim for reimbursement for which there is a “reasonable prospect of recovery." If a loss is claimed and then subsequently all or some is actually recovered in a future year, the amount recovered would be considered taxable income. Thus, you may need to report additional income (or perhaps additional losses) in subsequent years depending upon the amounts actually recovered, if any, in these years.

  4. The year of discovery is typically the year in which an indictment or other criminal complaint is filed against the perpetrator of the scheme. In addition, many of these cases have a receiver appointed to be accountable for any potential future recoveries and the year a receiver is appointed is also a good test for the year of the discovery.

  5. The amount of the deductible loss is determined as follows:

Amount Invested in Scheme $_________________

Less any Withdrawals from Scheme $_________________

Less any Reimbursements or Recoveries $_________________

Amount of Loss to Deduct $_________________

  1. There are also “safe harbor" provisions in place which basically state that a deduction is permitted for 95% of the amount invested, less any amounts which have been recovered. If you are pursuing or will be pursuing a recovery, the 95% is reduced to 75% to account for a potential recovery.

  2. If you have an overall loss that you cannot use in full in the year it was discovered, you are permitted to carry this loss back up to five years (if the loss was in 2008 or 2009) or up to three years if the loss was in other years. It can also be carried forward for up to 20 years.

  3. These provisions apply to “qualified investors," which basically means that you must be a US resident who did not have actual knowledge of the pyramid scheme before it became public knowledge, that the pyramid scheme was not registered as a tax shelter and for which cash or property was actually invested.

  4. If you claimed a tax deduction for a prior year for the pyramid scheme (such as for investment advisory fees), these amounts must be backed out before computing any current year tax deduction.

  5. If you are using the safe harbor provisions, you must mark “Revenue Procedure 2009-20" at the top of your Form 4684 (Casualty and Theft Losses) so the IRS will give you proper credit.

  6. Given the overall complexity of these issues, it is highly recommended that you seek advice from your tax professional on how best to handle any losses if you find yourself in this position.

Rate this guide


Recommended articles about Business

Can’t find what you’re looking for?


Post a free question on our public forum.

Ask a Question

- or -

Search for lawyers by reviews and ratings.

Find a Lawyer