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The Tax Prophet Newsletter   Issue # 68 December, 2008

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In This Issue:
Introduction
Theft Loss
Prospect of Recovery
Amended Returns
Conclusion


The Madoff Scam - Tax Relief for Victims?

Introduction

On December 12, 2008, Bernard Madoff confessed to operating a stunning $50 billion Ponzi scheme. A Ponzi scheme is a fraudulent investment operation that pays unusually high short-term returns to investors from money obtained from subsequent investors, rather than from actual earnings and profits ( "rob Peter to pay Paul").

Madoff's star-studded investor list included real estate magnate Mortimer Zuckerman; the foundation of Nobel laureate Elie Wiesel; Sen. Frank Lautenberg; a charity of movie director Steven Spielberg; actor Kevin Bacon and his wife, actress Kyra Sedgwick; and owner of the New York Mets, Fred Wilson. Also victimized were numerous Jewish charities, banks and investment houses.

Theft Loss

Madoff's conduct should meet the tax code's definition of a theft loss, which includes financial frauds. My recent newsletter on Theft Losses discusses the technical aspects of claiming the deduction. A theft loss is an ordinary loss (not a capital loss), that may offset past and future ordinary income.


Prospect of Recovery

In essence, a theft loss occurs in the year of discovery (here, 2008), but the deduction is postponed until the taxpayer establishes there is no reasonable prospect of recovery. This could be several years in the future.

At this time, it is unknown whether Madoff hid funds in offshore accounts or acquired property that could be used to repay defrauded investors, so the theft-loss claim has not yet matured.


Amended Returns

Those who relied on Madoff's phony financial statements and paid taxes on "phantom income" (fictitious capital gains, dividends and interest) may claim a refund of those taxes. In general, the claim must be made within three years, commencing on the original return's filing date.

Refund claims are not directly related to a theft-loss deduction, so taxpayers should consider both approaches.


Conclusion

Madoff's victims should consider theft loss claims, as well as refunds for any taxes paid within the past three years on phantom income.

Unfortunately, tax exempt entities will not benefit from tax code deductions and must rely on discovery and eventual recovery of any money and assets traced to Madoff's scheme.




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All contents copyright 2008 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet is a registered trademark of Robert L. Sommers.