how do i write off a ponzi scheme investment. I need specifics, not the IRS publication "2009-9. Like what forms need to be filled out and submitted? Thank you
Did you ever receive proceeds from the scheme (in its early stage)? Did you report that as taxable income and pay tax in previous years?
I am in the same situation, I was the victim of a ponzi scheme the same tax year it was revieled in which he paid me a potion of my money as well as distributed and lossed the rest. My accountant filed my returns and now i owe $7k on top of what i lost, i want to amend that years taxes being it wasnt incme, an i do that?
Sorry for the spelling errors, my keyboard was in Spanish.
@crawford8010 Ponzi schemes are complicated and not supported by Turbotax. If your accountant thinks you owe income tax, you would need to see a different accountant to get a second opinion.
Likewise, if you paid income tax on income that was not "real" income, you will need an accountant or tax professional to help you claim the loss or amend your prior returns.
You are allowed to claim an Itemized Deduction for Theft Loss in Schedule A. Since you were the victim of a Ponzi Scheme this theft loss is not limited to the $100.00 floor or 10%-of-AGI limits and it can create a Net Operating Loss. You have two options:
Regardless of how you choose to report the loss, you must do so through Schedule A. Unfortunately TurboTax does not have the forms necessary to deduct a Theft Loss from a Fraudulent Investment Transaction. We recommend that you visit a local Tax Professional to handle your situation.
Follow up question
- I took the Ponzi scheme safe harbor (deducted 75% of theft loss) on schedule A (via form 4684) in my 2017 return. Have 25% left over for tax free future recoveries (starting to come in) under the tax benefit rule.
- Ponzi scheme company went into bankruptcy and was taken over by Receivership. Receiver liquidated the assets and is in the process of paying back the recoveries. Receivership also had to settle tort claims with investor group so the investors don't sue the Receiver (since they just became the Ponzi scheme company).
- Received one recovery payout from the Receiver so far. Also got a 1099 from the Receiver for the tort claim settlement portion of this payout. Total payout is slightly higher than the 25% loss not yet deducted. Ponzi scheme theft loss safe harbor treatment states the future recoveries <= undeducted portion (25% in my case) falls under tax benefit rule and are not added to gross income and therefore not taxed.
My question is
- If I include this 1099 to my gross income, how do I eliminate it from calculating tax liabilities? According to tax benefit rule, I should be able to not claim <= 25% as income. The only way to do that is to not include the 1099.
- There will be further recoveries and potentially more 1099s. What if a future 1099 amount straddles and goes above the 25% undeducted loss? I know I have to add to gross income for all recoveries > 25%. But then how do I report the fraction of the 1099 that is above the 25%?
My guess is I don't include these 1099s to my Turbotax even though the issuer reports them to IRS. Instead, I just calculate and include all recoveries > 25% as misc income on the tax year of the recovery. Is this correct?
UPDATE:
Slowly learning more info. Seems recoveries from insurance and asset liquidation provide tax free treatment opportunities (if unused theft loss deductions are available) while punitive recoveries (tort settlements) are taxable with 1099s. A bit surprising receivership issued 1099 for the tort settlement portion of the recovery. Recovery came from liquidating assets, really kind of crappy portion for converted into taxable recovery treatment.
You may be misreading or not understanding the Tax Benefit Rule. Until you recover the amount that reduced your income, the 25% may not come into play or reduce the current income. The proration in the examples is two different types of state tax which are used to determine the amount that actually reduced income and income tax. Ultimately, it is determined based on how much your tax was reduced by the deduction. Worksheet 2 will help you determine the amount you must recover.
Tax benefit rule. IRS Publication 525
You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year.
Since the 75% used for your Ponzi Scheme loss was used 100% to reduce income, until that is recovered through your settlements received, I believe all settlement proceeds are taxable income. Once that is recovered the remainder will not be taxable. Again, Worksheet 2 in the publication will help you figure out the amount you must include in your income.
With your TurboTax account open follow the steps below.
Keep the worksheet in your files for your records.
Oops, logged in from a different account than madmanc20 but am the same poster 🙂
Really helpful for pointing out misunderstanding of tax benefit rule and where to enter for TTax. So then the fact that I receive 1099 or not is irrelevant? Just report all recoveries <= 75% as taxable in year of recovery and everything above 75% no need to report.
Yes, you are correct. Report your recoveries in the year of recovery and that is it.
Thanks. Very helpful.
Went through pub 525 worksheet 2. Looks like it mainly redo deduction year standard/itemized deduction calculation with respect to cumulative recoveries so far.
Following up on this since 2 separate CPAs handling friend's ponzi scheme loss are doing differently than suggested here
- If claim 75% loss in prior year tax return. This means tax payer reasonably expect 25% recovery
- Tax benefit rule only applied after recovery exceed the estimated recovery (25% in this example)
Here is an article suggesting similar. See section "Subsequent year adjustments"
Here is the language on IRS Revenue Ruling 2009-09. A bit hard to read but I think states the recoveries are first untaxed up to the undeducted portion (underlined). Amount beyond this is taxed following tax benefit rule.
A may deduct the theft loss in Year 8, the year the theft loss is discovered, provided that the loss is not covered by a claim for reimbursement or other recovery as to which A has a reasonable prospect of recovery. To the extent that A’s deduction is reduced by such a claim, recoveries on the claim in a later taxable year are not includible in A’s gross income. If A recovers a greater amount in a later year, or an amount that initially was not covered by a claim as to which there was a reasonable prospect of recovery, the recovery is includible in A’s gross income in the later year under the tax benefit rule, to the extent the earlier deduction reduced A's income tax. See § 111; § 1.165-1(d)(2)(iii). Finally, if A recovers less than the amount that was covered by a claim as to which there was a reasonable prospect of recovery that reduced the deduction for theft in Year 8, an additional deduction is allowed in the year the amount of recovery is ascertained with reasonable certainty.
Have a follow up question regarding 1099-MISC received from Ponzi scheme loss recovery.
Received this because it was required by law for tort claim settlement. However, the recovery is non taxable (still recovering the non-deducted portion (25%) from prior year (2017) Ponzi scheme safe-harbor deduction)
I worry not including this 1099-MISC into Turbotax can trigger an audit since IRS received this 1099-MISC. However, there is no way to mark it non-taxable after entering into turbotax. Interview questions after 1099-MISC offers no option.
Is there anyway to do this? Or just not include it in the tax return? Will be saving records clearly indicating Ponzi scheme loss, safa harbor deduction, non taxable and taxable recoveries.
Assuming the proceeds from the court case reported to you on Form 1099-MISC are solely for the loss in the value of your investment, it does not need to be reported on your tax return. Instead, it reduces your "basis" (net investment) in the investment you made.
Report the disposition of your remaining investment by following these steps:
Federal>>Income & Expenses>>Stocks, Mutual Funds, Bonds, Other.
When you add the "sale", it will ask you if you did or will receive a Form 1099-B. When you answer "No", TurboTax will walk you through the entry of the disposition of your asset. Report "zero" for the "Proceeds", and report your net investment (after the court payment) in the "Cost or Other Basis". Use the date of the court ruling as the "Date sold or disposed".
If the Form 1099-MISC reports payments for something other than loss in the value of your investment, it may be taxable. Refer to IRS Publication 4345 for guidance on whether the payment is taxable.
More information from IRS Tax Relief Legal Encyclopedia for guidance:
Under the IRS rules, an investor in a Ponzi scheme is entitled to deduct his or her losses as a theft loss, instead of a capital loss from an investment. This is good for the investors because the deduction for capital losses from investments is normally limited to a maximum of $3,000 per year. There is no such limit for theft losses. In addition, investment theft losses are not subject to the limitations applicable to personal casualty and theft losses. The loss is deductible as an itemized deduction. It is not subject to the 10% of adjusted gross income reduction or the $100 reduction that applies to many personal casualty and theft loss deductions. A theft loss deduction that creates a net operating loss for the taxpayer can be carried back three years and forward 20 years. This enables a victim to get a refund on prior taxes paid for those prior years.
The theft loss is deductible in the year the fraud is discovered, except to the extent the investor has a claim against the Ponzi schemer with a reasonable prospect of recovery. The IRS says that determining the year of discovery and applying the “reasonable prospect of recovery” test to any particular theft is highly fact-intensive and can be the source of controversy.
To help Ponzi scheme victims, the IRS has created a special “safe-harbor rule” under which it will automatically accept Ponzi-type theft losses. Under this rule, the IRS will deem the loss to be the result of theft if: (1) the scheme’s promoter was charged under state or federal law with fraud, embezzlement, or a similar crime; or (2) the promoter was the subject of a state or federal criminal complaint alleging commission of such a crime, and (3) either there was some evidence of an admission of guilt by the promoter or a trustee was appointed to freeze the assets of the scheme.
The amount of the theft loss includes the investor's unrecovered investment, including income as reported in past years. Defrauded investors generally can claim a theft loss deduction not only for the net amount invested, but also for the so-called “fictitious income” that the scheme’s promoter credited to the investor’s account and which the investor reported as income on his or her tax returns for years prior to discovery of the scheme.
Thank you for the detail response.
The original Ponzi loss safe harbor deduction was under Sched A Other Misc Deductions. Therefore, the deduction reduced ordinary income.
If I track basis in Sched D, then taxable recoveries are treated as investments and subject to ST/LT and suspended CG loss. I have a bunch suspended CG loss and would eliminate all the taxable recoveries.
Doesn't quite make sense the Safe Harbor deduction reduced ordinary income and recoveries are treated as capital gains+loss. I of course would benefit greatly but seems like IRS would want to deduction and income treated similarly.
I do have the taxable/untaxable portion of the recoveries tracked precisely and maintained for records. Along with principle and phantom incomes for total loss value.
I am a recent victim of the Ponzi scheme. The promoter of the scheme escaped the country and is missing. He was an international citizen. The authorities are not taking the complaint as according to them it's a civil case and not criminal. The promoter ran away with money from multiple investors. All of us tried but looks like we may not be able to find him or recover our investment now.
I have a few questions.
1. I reported it on FTC. Do I need to report it anywhere else?
2. Will this qualify as a Ponzi scheme loss? If so, do I need to report it to IRS now or while filing my tax return in Mar/Apr 2023?
3. Can anyone explain the steps for claiming it in IRS loss in layman's terms?
Appreciate your help!
I was a part of a big ponzi scheme where $0.5 billion was lost from investors big and small. SEC got involved. Multiple lawsuits filed by SEC and private lawyer groups targeting multiple groups and individuals. Receivership (appointed to handle bankruptcy) established to sell assets for maximum return that occurred over multiple years. Ultimately 90% of loss was recovered (after lawyer's cut and receiver's expenses) with multiple years of tax filing complexity and lost opportunity cost of course. I'll answer your question from this perspective.
General Background
- First I believe tax relief for Ponzi scheme loss is still available after the sweeping TCJA. Mine occurred before TCJA but recoveries occurred after.
- IRS wants some activity to confirm was Ponzi scheme (like some of those in my case) Can't just be your word. If overall loss was large by multiple investors (including small institutional) then many lawyers will get involved. Their activities likely will meet IRS Ponzi scheme defn (like filing a lawsuit)
- Many people will say work with a CPA and yes thats true. But know most CPAs are inexperienced with this even from big firms. Big firms might have many CPAs and some probably have handled Ponzi loss before and can offer experience. IRS guidelines leave huge amount of details ambiguous. Any CPA that haven't done it before needs to read the rules, maybe ask for clarification, and finally determine how aggressive and conservative to interpret the ambiguity within the rules (I saw a wide range of conservative vs aggressive interpretation amongst the various investor's CPAs)
- Turbotax back in 2017+ didn't handle ponzi scheme. Just punts. Understandable given the IRS ambiguities.
With this as background, here are general steps
- First all the IRS details are here. A long read and still leaves much ambiguity when getting to real mechanics. Help for Victims of Ponzi Investment Schemes | Internal Revenue Service (irs.gov)
- IRS wants a year of discovery. This kind of starts the clock on when this loss can be part of your tax return. This is first ambiguity. Is it when you learned of the loss through a verbal coversation? When legal action has been filed?
- IRS has a safe harbor guideline. Generally, you can take 75% loss on year of discovery leaving 25% as expected recovery. Or 95% loss on year of discovery with no expected recovery. Claimed losses are above the line (pre tax dollars) so basically offsetting income in year of discovery. File form 4684 (this is where turbotax punts) Loss rolled into my Sched A back in pre TCJA 2017. Don't know what sched it rolled up to now (and any associated haircuts or limits) If claim 95% loss, is first 5% of recovery tax free? (I don't know, I took 75% path)
- In subsequent years if recoveries come in. Keep your own ledger and first 25% of recovery is tax free if taken 75% safe harbor. Beyond 25% is taxable as other income in schedule 1 (in 2021 for me)
Key ambiguity in IRS rules
- Year of discovery. I know of CPAs that loss money claim year of loss was the day they got a phone call from investment advisor hearing of the potential loss (near end of year) It was favorable for the CPA to take loss on that year so aggressively used this as discovery year. Many of us waited until lawsuit was filed the subsequent year.
- Safe Harbor rules used the word "criminal". Tax payers/CPAs wonder if this means federal or local police action. In my case, no criminal action was ever taken but civil lawsuits was sufficiently comfortable for every investor + CPA.
Recovery mechanics
- How do you project amount of recovery to decide 75% or 95% safe harbor path? This is really hard. In the beginning there is so little info to make an estimate. Generally speaking, more lawyers that gets involved = more chance of recovery as they see opportunities. Recoveries in my case came from 1) class action lawsuit to the auditor (one of the biggies) This was like 60% of the loss recovered. I think total of like $300M+ was paid by the auditor 2) selling off remaining assets from bankruptcy 3) Lawsuit to investment advisor that had conflict of interest. Recovery capped by their maximum insurance payout.
Best to huddle with other investors with loss. Cross share+gain knowledge from everyone's CPAs. Lawyers representing a group seeking to take % of recovery may talk to you for free. But the lawyers after really big $ like from auditors have no reason to talk to individual investors. Anyway, lots of things to understand and many ambiguities.
- In general, recoveries are reported to IRS on an honor system with a simple one line "other income" in sched 1. I kept good ledger that doesn't need to be filed just for records.
- If ponzi scheme is large, "recovery investors" will offer you penny on the dollar for your loss. You get rid of multiyear headache, they patiently go through the recovery mechanics and profit.
Other complexities
- If investments received "income" that was never paid out but marked to be paid later when investment matures . You could have received a 1099 and paid taxes on it. This is called phantom income and added to the loss total
- If there is financial benefit to spread out the loss over years (say heading into lower income years), there are loss carry forward rules. Wasn't my case so not as well versed.
Hope this provides a general layman guidance. Complex matter. First need to know if have enough ammo to claim Ponzi loss according to IRS defn. If you are part of bigger loss by many people, chances are probably better. I don't know the case for small individuals that were defrauded.
I'm not a CPA but use TTax to handle employment, investment, rental tax filing for all family members in 3 different states. Ponzi scheme was the most complex simply due to rules ambiguity. Its not a common high volume tax filing case so IRS has no incentive to spend time on it. I was advised to use a CPA to claim the the loss. Used TTax to handle all subsequent year recoveries with just a note "recovery for ponzi loss in year XXXX" and kept a ledger to calculate taxable portion of recovery as they came in.
for Ponzi-type losses, you use section C in form 4684 to start. i advise you to read the instructions for the form and PART II of section C.
from that part.
If I have determined the amount of my theft loss deduction using 0.95 on line 46 above, I declare that I have not pursued and do not intend to pursue any potential third-party recovery, as that term is defined in section 4.10 of Revenue Procedure 2009-20.
if you intend to pursue 3rd-party recovery you can only take 75% (line 46)
since the loss involves income-producing property it will go to Schedule A. so you need to be able to itemize to benefit.
one other thing to be wary of that can affect your loss. Clawbacks. that's when attornies sue early investors that got money back to claim it for the recovery fund. This was quite a mess when it came to Madoff
@madmanc20 Thanks for the detailed response. This is super helpful.
Can I ask if the Ponzi fraud guy was arrested in your case? Just trying to understand if this changes anything with the IRS filings.
Ponzi scheme was Aequitas. Started as buying defaulted hospital debt for collection. Then expanded into loaning $ for fly by night private university (Corinthian) and other questionable $ making schemes.
- SEC filed a lawsuit. Their lawsuit wording said "Ponzi-like" and that provided the ammo for tax payers to follow IRS Ponzi deductions. Here is the actual filing with "Ponzi-like" wording. Aequitas Management, LLC, et al. (Release No. LR-23485; March 11, 2016) (sec.gov)
- Auditor Deloitte was sued by big firm class action lawyers
- Smaller investment advisors sued by investors group represented by small firm lawyers
- No criminal actions ever taken against the company principles or anyone
So clearly criminal action was not necessary. But SEC with past Ponzi experience knew the need to say "Ponzi" for investors to do their taxes. BTW, IRS safe harbor procedures all came out of Madoff aftermath. I guess rich Madoff clients needed a clear tax deduction process 🙂
I'd imagine if the total $ lost is smaller (say $10M by few investors) then a fed agency like SEC will not get involved and defining "Ponzi" is trickier. If no gov agency says "Ponzi" then you are left with IRS Ponzi procedure definition. Are there other ways? Maybe seeking out CPAs who can gather precedence of similar case and monetary scale might be one way to decide. Of course then need to rely on CPA's aggressive or conservative interpretation of vague or incomplete rules. But they can also contact IRS for clarification. I know one investor's small scale CPA did just that.
Another note is if the collective $ lost is big, a lot of lawyers will show up. Big class actions are taken by the big firms. But smaller lawyers will show up with seemingly helpful info (like website since they know investors will search and/or get interviewed by the media) to collect as many investors as possible for them to represent and be involved. Just beware, they are trying to gather a group and you need to determine which groups has what value to you.
I’m a victim of Ponzi scheme and can anyone recommend a CPA who knows how to file tax return for Ponzi scheme victim?
contact your state CPA society for names. a PONZI loss is claimed on form 4684 either section B or C depending on which allowable procedure is followed. it's a little tricky.
I have provided a link to the instructions for the form. section B instructions are on page 7 and section C on page 8.
https://www.irs.gov/pub/irs-pdf/i4684.pdf
after reading it you may well conclude that it is best to use a pro so it is done right.
If there are other investors with same ponzi scheme loss, pool you knowledge together. IRS wants some authority to say "Ponzi like". Any government offices getting involved is helpful to this cause. How big is the collective Ponzi loss? I'd think total loss have to be pretty (multiple 10s of millions? by all collective investors) before government agencies act.
Thanks Mike9241. I will contact CPA society of Oregan to find a CPA who knows Ponzi scheme but based on the posts on the social media, not many CPAs know Ponzi scheme tax filling.