Posted by Carmen Garcia

Use the IRS Safe Harbor Exemption for Ponzi Losses

Use the IRS Safe Harbor Exemption for Ponzi Losses

A Ponzi scheme is an investment scam in which the conspirator uses the money invested in creating a false return on the investment.

According to an article on CNBC.com, officials uncovered 60 suspected Ponzi schemes last year, totaling $3.25 billion in investor funding, the highest amount since the Great Recession.

The Great Recession (2007-2009) exposed Bernie Madoff's famous Ponzi scheme and prompted lawmakers and the IRS to create actionable actions for taxpayers, like the safe harbor described in this article. 

And here's more good news: The Tax Cuts and Jobs Act (TCJA), which eliminated most theft losses in fiscal years 2018-2025, allowed the tax deduction rules of the IRS to be deducted from the Ponzi scheme to remain in effect.


What does the safe harbor do for the taxpayer?

The IRS will not challenge a Ponzi scheme that uses the IRS tax cut as a safe harbor for the following loss treatments:

1. Ponzi losses are deductible as losses due to theft.

2. The loss is deductible in the year of discovery, which (in the context of this safe harbor) is the year in which a lead figure in the Ponzi scheme is: 

  • officially charged of committing fraud, embezzlement, or similar offenses;

  • is the subject of a state or federal criminal complaint and (a) pleads guilty, or (b) has assets frozen by a court administration or administrator; or

  • the subject of the fraudulent agreement, but (due to death) does not face charges of prosecution, information, or criminal complaint (this condition also requires that an administrator be appointed in part of the agreement or that the agreement's assets have been frozen.

3. The amount of loss is calculated using the Safe Harbor formula, which allows 95% or 75% of the loss during the year that the Ponzi scheme victim deposits in the Safe Harbor.

The Safe Harbor tax exemption makes it easier to simplify the Ponzi scheme theft and deduct losses for the victim.

In general, the IRS does not agree with theft loss deductions. The deduction rules and the different interpretations of the facts generate a good number of conflicts and disputes sufficient to make this harbor attractive.


How individuals and businesses claim the Ponzi Scheme Deduction

Suppose a thief breaks into your house and steals $100,000 worth of your property. Your deduction for theft and loss is zero if the loss is not attributed to a reported federal claim. This is per the TCJA rules for 2018-2025.

But the individual who accidentally invested in a Ponzi scheme did so for a profit. Tax law treats this theft differently than someone entering your home and stealing your valuables.

For-profit, the Ponzi scheme theft is fully deductible as an itemized deduction. The loss is not a capital loss limited to the maximum limit of $ 3,000. This is a fully deductible theft loss and can result in NOL.

The commercial treatment of the loss of Ponzi also produces a full deduction, albeit as an injury caused by workplace accidents.


Subsequent years

After you perform the safe harbor calculation and subtract 95% or 75%, you can collect a different amount the following year. This is not a problem. If you receive additional income, report the additional income in the collection year according to the tax benefit rule (as long as you received a benefit from the previous deduction).

Suppose the amount of your loss increases because you receive less than the amount of compensation you set as a reasonable prospect of recovery. In that case, you deduct the additional loss in the year that you can identify that additional loss with reasonable certainty.


Ponzi scheme Loss Carryback as an NOL

The individual taxpayer who becomes a victim of the loss or theft may consider their loss due to the theft as a sole proprietorship loss to calculate the NOL deduction.


Planning note: If you qualify for a 2020 Ponzi scheme loss deduction and that deduction results in an NOL, you can elect to forgo the refund and carry the loss forward.


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Carmen Garcia
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