Investment fraud

[ILLMAS]

TP invested $$$ thinking it was a legitimate investment, turns out it wasn't and the  U.S government prosecuted the culprits, and they are now required to pay back restitution when they get out of the slammer.  This happened in 2016, but in early 2019 the U.S government closed the case.  I have a couple of questions:

1.  Can the TP go back to 2016 and start reporting the loss on the investment even though it was fraud? Or 2019 when the case was closed.

2.  Just from the information I have, it doesn't seem it was a ponzi scheme, so would it be reported on Sch D or form 4864?

I don't believe this falls under the new declared disaster area circumstances.

[Lee B]

49 minutes ago, ILLMAS said:

, and they are now required to pay back restitution when they get out of the slammer.  This happened in 2016, but in early 2019 the U.S government closed the case. 

Your potential problem with this scenario is "when was the investment deemed to be unrecoverable"?

[Max W]

A decision was rendered on the case prior to it being closed.  Once the decision came down, a period of 60 days is allowed for an appeal.  If it did go to appeals, it could take a year.  I doubt there was an appeal, otherwise the case would still be open.

My guess is that the verdict was rendered in late 2018.

You should be able to look up the case and get confirmation of the date.

[Catherine]

Looking at what Max W just posted, I think you could make a case for the date the appeals period closed.  Yes, the decision was earlier - but no way to know if there would be an appeal, which would keep the case open.

[Max W]

We are all shooting in the dark here.  Most people are not conversant in legal terminology and often get it wrong. What did the client mean that the government closed its case?    If it refers to the case linked below, which could be the case referred to, they probably meant that the government closed its argument and the case went to jury.

The jury handed down its verdict and then the defendants filed an appeal.   When a defendant loses, there is almost always an appeal.  It is a CYA move for the attorneys.  A federal appeal moves fairly quickly, but could take from 6 months to a year.  

There are elements of a Ponzi scheme here as  individual account statements were issued showing falsified earnings.

https://www.justice.gov/usao-ndil/pr/chicago-investment-manager-convicted-federal-fraud-charges-swindling-10-million-clients

[Terry D EA]

My question as well, if this was, is or is being considered a Ponzi scheme. If so, there is a way to recover the loss. 

[Joel]

Terry,

I just went to IRS.GOV and typed 'ponzi' in the search panel. There are 13 articles for your review.  I have filed a few returns that included the ponzi deduction usually taking the 95% deduction unless the taxpayer had previously elected to be included in a class action suite.

 

[ILLMAS]

This was not a ponzi scheme and the U.S government that found these culprits guilty of fraud was the U.S Department of Justice.  According to TP, the department will be checking for the next 20yrs to see if the culprits have any money to pay back the investors.   TP in their heart know they will never get paid

 

I believe I found my answer to question 1:

 

Year of discovery with no reasonable prospect of recovery.

Determining the correct year in which to take the theft loss deduction may be the most troublesome aspect of the deduction. A taxpayer with an allowable theft loss who takes the deduction in an inappropriate year can face not only the disallowance of the deduction, but also substantial penalties and interest.

IRC section 165(e) states that any loss arising from theft shall be treated as sustained in the taxable year the taxpayer discovers the loss and is thus deductible in that year. The Treasury Regulations specifically note that the loss is not deductible in the year the theft actually occurs unless that is also the year in which the loss is discovered. The troublesome caveat, however, is found in Treasury Regulations section 1.165-8(a)(2); if in the year of discovery there exists a reasonable prospect of recovery or reimbursement, that portion of the loss may not be deducted until it can be determined that recovery or reimbursement will not occur. Furthermore, if it is “unknowable” if recovery will occur, the entire deduction must be postponed until it can be determined with reasonable certainty whether such reimbursement will be received.

A reasonable prospect of recovery exists when the taxpayer has a bona fide claim for recovery or reimbursement and there is a substantial possibility that such claims will be decided in the taxpayer’s favor. The Tax Court has explained that a taxpayer does not have to be an “incorrigible optimist,” and claims for recovery whose potential for success are remote or nebulous will not cause a postponement of the deduction. Furthermore, the court does not look at facts whose existence was not reasonably foreseeable as of the end of the year in which the loss was discovered. In other words, the fact that the taxpayer subsequently succeeded in a legal action on the claim does not necessarily mean that no reasonable prospect of recovery existed in the year the deduction was taken [Ramsay Scarlett & Co. v. Comm’r, 521 F.2d 786 (4th Cir. 1974)].

This standard presents important considerations for taxpayers who are determining whether there is a reasonable prospect for recovery in a given year. If a taxpayer files suit against the perpetrator or joins in an existing suit, a prospect for recovery is usually deemed to exist. The lengthy process of lawsuits and receiverships can, however, delay the allowance of the claim. A similar delay in deductibility may occur when the taxpayer files bankruptcy claims against the perpetrator of the investment theft. In Bunch v. Comm’r (TC Memo 2014-177 2014), the Tax Court ruled that the taxpayers had a reasonable prospect of recovery at the end of the discovery year because they had filed a claim in connection with the perpetrator’s bankruptcy proceeding and it had not yet been proven that there would be no assets with which to pay the claims.

Another consideration for taxpayers is the cost of litigation. Because “reasonable prospect of recovery” is a factual determination, it is usually not resolved by a motion for summary judgment. This means that a full trial may be needed to win against an IRS action. The cost is often prohibitive for many taxpayers.

 

Source:  https://www.cpajournal.com/2016/10/01/the-defrauded-investors-solace/