5 ways to recover from a Ponzi scheme |
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However, others who were involved in varying degrees with the fraud may also be liable and have additional assets, says Alan Cosner, a former IRS agent and attorney in East Brunswick, N.J. Perhaps there were people who took part in transactions related to the scheme who knew about it but didn't act, says attorney Ron Geffner, a partner with Sadis & Goldberg in New York and a former lawyer with the Securities and Exchange Commission.
In the Madoff case, there were "feeder funds" that placed money from their investors with Madoff, perhaps without those investors' knowledge. Unbeknownst to Loretta Weinberg, a New Jersey state senator, her financial adviser in California invested her money with Madoff. The result: Her life savings, more than $1 million, is gone.
There also may be accounting firms, banks or other individuals who were negligent in not spotting the fraud, Page says. In February, the charitable foundation of Sen. Frank Lautenberg and two of his children sued Madoff's brother Peter, who was the chief compliance officer and general counsel of Bernard L. Madoff Investment Securities. Peter Madoff has not been charged criminally in the case.
Some situations may exist in which individual victims have claims unique to them or a small group of investors, depending on how they became involved in the scheme and other factors, Page says. That could be helpful, especially if a fraud impacted hundreds or thousands of investors, all of whom are looking for ways to recover their money.
3. Claim losses for previous tax years
One of the best ways for investors caught in a Ponzi scheme to mitigate their losses is to go to their favorite uncle -- Uncle Sam. Federal tax rules offer investors a couple of ways to get money back -- in some cases as much as 50 percent of their loss.
"In the Madoff case, probably the greatest recovery is going to come through tax relief," says Levine, chairman of the tax department at Herrick Feinstein in New York. "The problem is (that) there really is no clear authority on exactly how this is going to work."
The most popular options are filing an amended income tax return for previous years, and using the "theft-loss" deduction. However, taxpayers can only amend returns for the prior three years, no matter how long the scam may have been operating, Levine says.
The benefit comes from recharacterizing what previously was considered profit from the scheme, profit that an investor paid taxes on. Now, it's considered phantom income, meaning the investor overstated their taxable income and would be eligible for a refund.
The theft-loss deduction is a bit more complicated. Richard Lehman, a tax attorney in Boca Raton, Fla., says investors who have unreturned principal or phantom profit from a fraud are, in many cases, entitled to deduct that amount from other income they earned.
Earlier this week, the IRS issued guidance on the tax issues related to Ponzi schemes following IRS Commissioner Doug Shulman's testimony before the Senate Finance Committee. In essence, the IRS will allow victims of a Ponzi scheme to claim a theft loss, which is the investors unrecovered investment, including income, reported in prior years.
In addition, the IRS provided what it calls "two simplifying assumptions" for taxpayers regarding what qualifies as a theft loss and how much of their loss they can deduct if they expect to recover some money from the fraud. (See Shulmans prepared testimony and guidance details.)
Individual circumstances and facts ultimately determine whether a taxpayer can apply the theft-loss deduction. If the losses exceed a taxpayer's income for a particular year, those losses can be applied to tax returns from the previous three years and forward 20 years, Levine says. Tax law prohibits taking a theft loss until there is no longer a reasonable expectation of recovery from elsewhere, such as the Securities Investment Protection Corp., or SIPC, or a trustee, he says.
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