Permalink Submitted by Alan Spross on Fri, 2010-07-02 23:55
The following is copied from a tax attorney’s blog in March, 2009, at the height of the Madoff fraud:
>>>>>>>>>>>>>>>
Theft Loss
A theft loss could potentially be available in relation to a Roth IRA since a Roth IRA has basis. Any loss arising from theft is allowable as a deduction under Code Sec. 165(a). There is currently no guidance from the IRS on whether this is a remedy available to a Roth IRA or traditional IRA with basis, but practitioners should consider filing protective claims to leave this possibility open.
Preparing Income Tax Returns
At the time of this writing, the IRS has not provided guidance with regard to the proper tax treatment of the theft loss, phantom income, and IRA issues. This creates a tremendously complex situation for CPAs and tax attorneys preparing and providing advice to Madoff investors. The most pressing issue is filing amended returns, or at least protective claims, with regard to the 2005 phantom income. For federal tax purposes, the statute of limitations on most 2005 returns will lapse on April 15, 2009. Naturally, once the statute of limitations has lapsed, those years will now be “closed” for tax purposes and taxpayers will be barred from making future claims. As discussed above (see page 6), many practitioners believe that an amended return should be filed to remove the phantom income from an individual’s return. To accomplish this, one would file a Form 1040-X (Amended U.S. Individual Income Tax Return), removing the “income” from the return. Although it is impossible to say for certain because of Greenberg and Taylor, discussed above, it would appear that substantial authority exists for this position. Further, to the extent that the client would like to receive 2006 and 2007 refunds in a timely manner, amended returns could also be filed for those years, as well. Unlike the carryback of the theft loss, to be discussed below, the refunds, if any, associated with the 2005, 2006 and 2007 returns, will carry interest. However, unlike the 45-day rule for the theft loss, the IRS does not have a time frame, in which they have to answer the amended return.
If a person is not comfortable filing these amended returns but would prefer to wait for guidance from the IRS, a protective claim should be filed. The protective claim, when filed properly, tolls the statute of limitations until the IRS responds. If the IRS responds denying the claim, then the taxpayer would be able to file a suit in federal District Court or in the U.S. Court of Claims. Because there is not a tax due per se, but rather a refund is being requested, it appears that one could not file a petition in the U.S. Tax Court.
The Theft Loss Itself
Assuming that practitioners can get to the point where they believe a theft loss is warranted, they would prepare a 2008 return claiming the theft loss. To the extent that the theft loss exceeded 2008 income, they would then have a choice of carrying the theft loss back three years and/or forward for a period of 20 years. Further, some investors, in small business partnerships, may be able to carry the loss back for a period of five years. 86
To take a simple example, if a taxpayer invested $5 million in late 2008, never reported any gains or losses, and is expecting a SIPC recovery of $500,000 and a bankruptcy recovery of $100,000, he or she would take a theft loss deduction of $4.4 million. The taxpayer would also file a protective claim for the remaining $600,000. The protective claim allows for the possibility that there is no further SIPC or bankruptcy recovery.
This loss could then be carried forward or carried back, based upon the taxpayer’s personal tax strategy. In the event that the taxpayer reported substantial capital gains in earlier years, with very little ordinary income, it may not be prudent to carry the loss back. However, if the taxpayer reported substantial ordinary income from other investments in earlier years, carrying the loss back may be a good idea and would result in a timely refund. The tax preparer will need to carefully analyze the benefit of removing phantom income and carrybacks or carryforwards. Modeling various scenarios will be advisable until a somewhat optimal mathematical solution can be determined.
Perhaps the most important thing to remember will be to always file protective claims for alternative positions. For example, if a person following Greenberg 87 and Taylor 88 were to file a return removing phantom income, they would also file a protective claim adding the phantom income to their total theft loss. Although taxpayers need to be careful not to double count by removing income and availing themselves of the theft loss deduction for the same income, they must also be cautious not to let a particular statute of limitations lapse.
>>>>>>>>>>>>>>>>>
Permalink Submitted by BruceM on Mon, 2010-07-05 19:29
So where exactly would the loss be taken on one’s tax return?
This narrative doesn’t seem to exactly say, but it sounds like it is recommending a schedule D for treatment as a capital loss? If so, that doesn’t sound right. I would think it would be either taken as a misc itemized deudction subject to 2% of AGI limitation, or as a theft loss on Sched A, subject to 10% of AGI limitation.
Permalink Submitted by Alan Spross on Mon, 2010-07-05 22:37
Looks like it would have to be a casualty loss on Sch A, to have the ability to generate a NOL that can be carried back or forward, although he does not show the 10% AGI limitation, perhaps because those limits include the affect of other such losses, as unlikely as that may be.
Permalink Submitted by Alan Spross on Fri, 2010-07-02 23:55
The following is copied from a tax attorney’s blog in March, 2009, at the height of the Madoff fraud:
>>>>>>>>>>>>>>>
Theft Loss
A theft loss could potentially be available in relation to a Roth IRA since a Roth IRA has basis. Any loss arising from theft is allowable as a deduction under Code Sec. 165(a). There is currently no guidance from the IRS on whether this is a remedy available to a Roth IRA or traditional IRA with basis, but practitioners should consider filing protective claims to leave this possibility open.
Preparing Income Tax Returns
At the time of this writing, the IRS has not provided guidance with regard to the proper tax treatment of the theft loss, phantom income, and IRA issues. This creates a tremendously complex situation for CPAs and tax attorneys preparing and providing advice to Madoff investors. The most pressing issue is filing amended returns, or at least protective claims, with regard to the 2005 phantom income. For federal tax purposes, the statute of limitations on most 2005 returns will lapse on April 15, 2009. Naturally, once the statute of limitations has lapsed, those years will now be “closed” for tax purposes and taxpayers will be barred from making future claims. As discussed above (see page 6), many practitioners believe that an amended return should be filed to remove the phantom income from an individual’s return. To accomplish this, one would file a Form 1040-X (Amended U.S. Individual Income Tax Return), removing the “income” from the return. Although it is impossible to say for certain because of Greenberg and Taylor, discussed above, it would appear that substantial authority exists for this position. Further, to the extent that the client would like to receive 2006 and 2007 refunds in a timely manner, amended returns could also be filed for those years, as well. Unlike the carryback of the theft loss, to be discussed below, the refunds, if any, associated with the 2005, 2006 and 2007 returns, will carry interest. However, unlike the 45-day rule for the theft loss, the IRS does not have a time frame, in which they have to answer the amended return.
If a person is not comfortable filing these amended returns but would prefer to wait for guidance from the IRS, a protective claim should be filed. The protective claim, when filed properly, tolls the statute of limitations until the IRS responds. If the IRS responds denying the claim, then the taxpayer would be able to file a suit in federal District Court or in the U.S. Court of Claims. Because there is not a tax due per se, but rather a refund is being requested, it appears that one could not file a petition in the U.S. Tax Court.
The Theft Loss Itself
Assuming that practitioners can get to the point where they believe a theft loss is warranted, they would prepare a 2008 return claiming the theft loss. To the extent that the theft loss exceeded 2008 income, they would then have a choice of carrying the theft loss back three years and/or forward for a period of 20 years. Further, some investors, in small business partnerships, may be able to carry the loss back for a period of five years. 86
To take a simple example, if a taxpayer invested $5 million in late 2008, never reported any gains or losses, and is expecting a SIPC recovery of $500,000 and a bankruptcy recovery of $100,000, he or she would take a theft loss deduction of $4.4 million. The taxpayer would also file a protective claim for the remaining $600,000. The protective claim allows for the possibility that there is no further SIPC or bankruptcy recovery.
This loss could then be carried forward or carried back, based upon the taxpayer’s personal tax strategy. In the event that the taxpayer reported substantial capital gains in earlier years, with very little ordinary income, it may not be prudent to carry the loss back. However, if the taxpayer reported substantial ordinary income from other investments in earlier years, carrying the loss back may be a good idea and would result in a timely refund. The tax preparer will need to carefully analyze the benefit of removing phantom income and carrybacks or carryforwards. Modeling various scenarios will be advisable until a somewhat optimal mathematical solution can be determined.
Perhaps the most important thing to remember will be to always file protective claims for alternative positions. For example, if a person following Greenberg 87 and Taylor 88 were to file a return removing phantom income, they would also file a protective claim adding the phantom income to their total theft loss. Although taxpayers need to be careful not to double count by removing income and availing themselves of the theft loss deduction for the same income, they must also be cautious not to let a particular statute of limitations lapse.
>>>>>>>>>>>>>>>>>
Permalink Submitted by BruceM on Mon, 2010-07-05 19:29
So where exactly would the loss be taken on one’s tax return?
This narrative doesn’t seem to exactly say, but it sounds like it is recommending a schedule D for treatment as a capital loss? If so, that doesn’t sound right. I would think it would be either taken as a misc itemized deudction subject to 2% of AGI limitation, or as a theft loss on Sched A, subject to 10% of AGI limitation.
What do you think?
BruceM
Permalink Submitted by Alan Spross on Mon, 2010-07-05 22:37
Looks like it would have to be a casualty loss on Sch A, to have the ability to generate a NOL that can be carried back or forward, although he does not show the 10% AGI limitation, perhaps because those limits include the affect of other such losses, as unlikely as that may be.