Ponzi schemes and Federal Tax Treatment

A client called me the other day and mentioned that he and his CPA were having some arguments over the tax treatment of a bad investment. After discussing the issue with the client, it came out that the client had been involved with a Ponzi Scheme and had lost all of his investment in the program. This is not the BIG Ponzi Scheme that came up recently with Bernard Madoff, but the end result was the same.

This topic will not apply to 99.9% of the readers out there, so I will not spend a lot of time on it. Note though that the CPA wanted to be conservative and treat the investment as a long term capital loss (limited to $3,000 deduction per year) and the client wanted to deduct it according to the tax rules regarding theft.

After doing a bit of research, the IRS has come out with two rulings this year to help taxpayers who have been subject to this type of scheme. Revenue Ruling 2009-9 deals with the exact question as to whether these are theft losses or capital losses and goes on to deal with questions such as what year are the deductions available, how is the value of the loss determined, what limits prevent a person from taking the whole amount as a deduction, and other aspects. The IRS also published Revenue Procedure 2009-20, which provides safe harbor treatment for those who were subject to such schemes and report the losses in a certain way. If you were one of the people who were affected by one of them, then you should speak to your CPA and show him or her these two IRS Rulings to ensure that you are able to properly treat the theft that occurred to you.