How do i write off a ponzi scheme investment. I need specifics, not the IRS publication. Like what forms need to be filled out and submitted? Thank you

[JS1022]

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!

[madmanc20]

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.

[Mike9241]

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 

[JS1022]

@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. 

[madmanc20]

@JS1022 

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.

[Borbom4ever]

I’m a victim of Ponzi scheme and can anyone recommend a CPA who knows how to file tax return for Ponzi scheme victim?

[Mike9241]

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. 

[madmanc20]

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.

[Borbom4ever]

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. 

[Borbom4ever]

I am pretty sure there are more victims. I used a blockchain investigation company to trace where my money went to and after they did initial research and found out that there were 4 millions dollars in a blockchain wallet. 

[madmanc20]

Blockchain investing is tricky. Fed gov is just starting to try to tax crypto much less police it.

My case was $600M case (not my personally haha) with institutional investors and SEC got involved. SEC filed suit in civil court. Class action lawyers went after auditor (Deloitte). SEC produced a document writing "ponzi-like" language fully knowing thats what investors and their CPAs need it.

If can't connect with other investors, then more learning alone rather than in group. On CPA, bigger firms with more CPAs usually have someone that has experienced it. Even if don't work with that CPA, they can get guidelines from colleague. My tax year claiming ponzi loss was done through a investment advisor company managing few $B assets with a tax department with probably 10+ people. This type of company has seen a lot that has occurred with investor's money and are well connected with estate lawyer and CPA firms. I had a very junior CPA that did my tax return, ponzi loss documentation is actually quite trivial but they were guided by the head of CPA dept who was very senior and seen Ponzi loss before.

So perhaps that offers you another consideration in case you are working with a larger investment firm. Small investment advisors don't have the scale but of course its very individual. They would be experts if they seen it once.

[Borbom4ever]

Thanks and your information was very helpful. Do you mind to tell me the name the investment advisor who did tax return for you and I can contact them to see if they can file 2022 year tax return for me. Most of CPAs are individual as you said. That is correct. More likely they never have experience to file Ponzi scheme related tax returns. My case was not related to SEC and it was crypto currency scam in Coinbase wallet. The chance of get funds recovered was very little or very difficult because the money was out side US now. 

[madmanc20]

Investment advisor is Brighton Jones. I think their CPAs probably only do returns for investment clients. Advising fee is much bigger than tax prep fee so tax prep is just a way to add tax expertise to investment group and able to generate their own accountability.

I guess if no gov jurisdiction will say "Ponzi". Bring civil or criminal action. You may have challenge to claim Ponzi. But of course that only matters at an audit so depending on your/CPA risk tolerance.

Don't know how limited theft loss tax code is now but its another avenue if your situation fits.

[Borbom4ever]

Thanks and I am very appreciate for you providing this information. You brought up a good a point about that my loss was Ponzi scheme or not. Based on my attorney said that there is a Safe-Harbor Tax Relief for Ponzi Scheme Losses¹ for USA taxpayers. A Ponzi scheme is defined as an investment fraud where the schemer uses invested money to create fake investment returns. Shazhupan / Pig-Butchering Scams can be categorized as Ponzi Schemes. So my case was Pig-Butchering. 

[Mike9241]

ask specifically if they have filed returns reporting Ponzi scheme losses.   these days it is not that uncommon

and the rules go back to about 2009 so CPAs have had more than 10 years to do returns with this type of loss. 

some probably handled the Madoff Ponzi loss for their clients 

Rev Proc 2009-20 as modified by 2011-58 is a safe harbor procedure if you meet all the requirements listed in Section C of form 4684. and rev proc 2011-58

from rev proc 2011-58

Section 4.02 of Rev. Proc. 2009-20 is modified to read as follows:

.02 Qualified loss. A qualified loss is a loss resulting from a specified fraudulent arrangement in which, as a result of the conduct that caused the loss—

(1) A lead figure was charged by indictment or information (see, for example, Fed. R. Crim. P. 7) under state or federal law with the commission of fraud, embezzlement, or a similar crime that, if proven, would meet the definition of theft for purposes of § 165 of the Internal Revenue Code and § 1.165-8(d) of the Income Tax Regulations under the law of the jurisdiction in which the theft occurred, and the indictment or information has not been withdrawn or dismissed (other than because of the death of the lead figure);

(2) A lead figure was the subject of a state or federal criminal complaint (see, for example, Fed. R. Crim. P. 3) alleging the commission of a crime described in section 4.02(1) of this revenue procedure, the complaint has not been withdrawn or dismissed (other than because of the death of the lead figure), and either—

(a) The complaint alleged an admission by the lead figure, or the execution of an affidavit by that person admitting the crime; or

(b) A receiver or trustee was appointed with respect to the arrangement or assets of the arrangement were frozen; or

(3) A lead figure, or an associated entity involved in the specified fraudulent arrangement, was the subject of one or more civil complaints (see, for example, Fed. R. Civ. P. 3, 7) or similar documents (such as a notice or order instituting administrative proceedings or other document the Internal Revenue Service designates) that a state or federal governmental entity filed with a court or in an administrative agency enforcement proceeding, and—

(a) The civil complaint or similar documents together allege facts that comprise substantially all of the elements of a specified fraudulent arrangement, as described in section 4.01 of this revenue procedure, conducted by the lead figure;

(b) The death of the lead figure precludes a charge by indictment, information, or criminal complaint against that lead figure as described in section 4.02(1) or (2) of this revenue procedure; and

(c) A receiver or trustee was appointed with respect to the arrangement or assets of the arrangement were frozen.

.02 Section 4.04 of Rev. Proc. 2009-20 is modified to read as follows:

.04 Discovery year (the year the loss can be claimed under this Rev Proc). A qualified investor’s discovery year is the investor’s taxable year in which—

(1) The indictment, information, or complaint described in section 4.02(1) or (2) of this revenue procedure is filed; or

(2) The complaint or similar document described in section 4.02(3) of this revenue procedure is filed, or the death of the lead figure occurs, whichever is later.

some taxpayers will not meet the revised safe harbor requirements. they have to use section B of the 4684.

this is why is virtually impossible to advise someone as to how to claim their loss without knowing a lot more about what happened. One shoe does not fit all