On September 24, 2010, the IRS released a letter (the “Letter”) addressing the availability of tax deductions for Ponzi scheme losses relating to assets held in individual retirement accounts (“IRAs”) or similar tax-deferred investment vehicles and assets held by charitable trusts. The Letter refers to Revenue Ruling 2009-9 for the general tax treatment to investors who lost money in Ponzi schemes and to Revenue Procedure 2009-20 for an optional safe harbor relating to deductions by qualified investors who lost money in Ponzi schemes.
Revenue Ruling 2009-9 generally provides that, among other things, investors who lost money in Ponzi schemes are entitled to theft loss deductions, which are generally deductible in the taxable year the investor discovers the loss or in the taxable year in which there is no reasonable prospect of recovery, whichever is later. Revenue Procedure 2009-20 generally provides a safe harbor under which the IRS will not challenge the timing of a theft loss deduction taken by a qualified investor who lost money in a Ponzi scheme in the taxable year in which authorities charge the perpetrator for the theft, provided the investor complies with certain requirements.
The Letter explains that the Internal Revenue Code generally limits a taxpayer’s loss or other deduction to the taxpayer’s cost or other basis to prevent multiple deductions or exclusions for the same amount. Accordingly, if a taxpayer has basis in a tax-favored retirement plan or IRA (e.g., because the taxpayer made after-tax contributions to an IRA), the taxpayer is entitled to a deduction to the extent of any unrecovered basis after the distribution of the taxpayer’s entire interest in the plan or IRA. In the case of an IRA, the total amount in all of the taxpayer’s traditional IRAs or all of the taxpayer’s Roth IRAs, as applicable, must have been distributed. However, if a taxpayer has no basis in the retirement plan or IRA, the taxpayer may not claim a deduction for the loss in such plan or IRA. Permitting taxpayers to take a loss deduction for amounts already deducted or excluded from gross income would provide those taxpayers with a double benefit (two deductions or a deduction and exclusion) for the same dollars, and would put those taxpayers in a more favorable tax position than other taxpayers who have the same losses outside of a retirement plan or IRA. The Letter also clarifies that only charitable trusts (and not their beneficiaries) may deduct theft losses for amounts that Ponzi scheme perpetrators stole from the trusts.