Madoff Investors Look To Uncle Sam For Bailout

by Leroy Baker, Tax-News.com, New York

22 December 2008

As the explosive revelations from the Bernard Madoff investment scandal continue to reverberate across the financial world, investors who have lost money in Madoff's funds may be able to reach for one crumb of comfort in the form of the US tax code, it has emerged.

With many investors still counting the cost of putting their trust - and substantial sums of money - into what has allegedly turned out to be Wall Street's largest-ever Ponzi scheme, tax advisors are pointing to certain sections of the US tax code which could allow investors to recoup significant sums through 'theft loss' provisions.

Under the theft loss rules, taxpayers can deduct a loss against 90% of their adjusted gross income, plus USD100. Therefore, an investor with an income of USD100,000 who lost USD1m would - theoretically - be able to deduct USD989,900. Also, because of the nature of the loss, taxpayers affected by the scam are entitled to claim an 'ordinary' (as opposed to a 'capital') loss deduction under section 165 of the US tax code, and therefore carry back unused losses by three years (as opposed to two). They can also carry forward unused losses to the next 20 tax years.

Whether the Internal Revenue Service would allow such a claim is another matter entirely. At the very least, taxpayers seeking such deductions, and especially those adjusting previous tax returns, can expect an IRS audit for their troubles.

"These victims of investment fraud may qualify for a little known tax break that until now, not many people have been eligible for," said Michael Rozbruch, founder and CEO of Tax Resolution Services. However, he warned that: "To recover your losses, you will need to go back and amend your tax returns, which means you will inevitably be audited." Rozbruch added that professional advice is essential for taxpayers in such scenarios.

Given the current economic climate and the likelihood of falling tax revenues in the year ahead, the IRS, which could face tax revenue losses in the billions of dollars (as much as USD17bn according to one estimate), is unlikely to want to become an unwitting victim of the Madoff scandal too. Therefore, it remains questionable at present whether the agency would uphold such substantial theft loss claims.

Since the December 11 arrest of the seventy-year-old Madoff, the list of companies and individuals facing steep financial losses based on their dealings with Madoff and companies affiliated with or controlled by him has grown to include individuals and institutions across the United States. In addition, Madoff's fund obtained money from some of Europe's largest banks, including institutions in the United Kingdom, Spain, France and Italy, and their clients.

"If this were a traditional bank robbery, the eyewitness reports would say that Madoff walked out with billions of dollars as someone held the door open for him," says Jeffrey Zwerling, a founding partner of Zwerling, Schachter and Zwerling, which has been retained by individuals and entities allegedly duped by Madoff.

"If it's true, it's just amazing in terms of the audacity, if nothing else," Zwerling observed.

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