@DoninGA @rjs @TomD8
This is a bit of a puzzle. You are getting 1099-MISC from the state, presumably, because the state is managing the payments. Here are my thoughts, but I welcome the advice of other experts.
The payments are not taxable income at the time they are received, until and unless they exceed the amount you originally invested. There is a way to zero them out in Turbotax so they won't be added to your income, but you will want to have an explanation prepared in case the IRS asks questions.
Then, whenever you receive the final payment and the resolution fund is closed, with no more payouts coming, one of two things will happen.
a. This is an investment loss. At the the time the final investments become worthless or the resolution fund is closed, you will report a capital loss on schedule D. You will report the amount of the original investment, and report it as a "sale", using the date the resolution fund closed, and the selling price is the amount of proceeds you received over time. You will be able to deduct the remaining capital loss against future capital gains. But you can't declare any investment loss until the final amount is known.
b. This is a theft loss. For 2018-2025, theft losses are not tax deductible. You simply collect whatever restitution you can get, and walk away. The restitution is not taxable income, but the remaining loss is not deductible. However, if the tax law changes, and the final loss occurs in a year when theft losses are deductible, you might be able to deduct the theft loss. (On the other hand, if the theft occurred between 2018 and 2025, the loss might never be deductible even if the law is different when the final payments are made, I'm not sure on this point.) (Since there is a fraud conviction, I think it is more likely the IRS will want you to treat this as a theft loss than an investment loss.)
Note that if you received periodic payments from this investment, and paid income taxes on those investment "gains" (which later turned out to be fake), you have a Ponzi scheme loss, not an ordinary theft loss, and Ponzi scheme losses are still deductible under current tax law (because you paid income tax on money that was never really yours). However, deducting Ponzi losses is complicated and you may need to see a tax professional.
