Moira Souza Shiver, expert on the application of IRC Section 165, has been asked by me to write this guest blog. The benefits of Section 165 can be substantial, yet there are few who are qualified to understand how to effectively navigate the regulatory maze to gain maximum benefit. As a business ethics and fraud prevention speaker, I try, through this blog, to provide a useful forum for discussing issues, and there is none more important at this time than the effective use of legal methods to recover loss.
Facts, Fiction and Future
Victims, taxpayers and citizens, in general, are experiencing an extraordinary chapter in American financial history. Economic challenges, budget deficits and tax implications lead the list of many issues confronting citizens and legislators. Surfacing in the midst of what appears to be mass chaos is yet another disturbing issue – victims of investment theft suffering irrecoverable losses in their life savings. One bright spot, with the uncovering of these massive investment scams, the media is finally bringing attention to the fact that there are hundreds of thousands of people across this great country who are suffering tremendously at no fault of their own.
For the last ten years, I have been fighting for financial recovery for victims of investment theft. There’s been a law on the books since 1954 that helps some victims, but most often it ignores the truly needy in favor of the wealthy. Unfortunately, it also requires a monumental struggle with the IRS to get the deserved relief. The pain and suffering these issues caused demanded I shift my focus and become an advocate for victims in three ways:
Investment Fraud Prevention Through Education
Maximize Recovery Through Legitimate Sources
Changes in the Tax Code to Carry Out the Intention of the Law
PROBLEM – LACK OF CLARITY, COUNTLESS (MIS)INTERPRETATIONS & INEXPERIENCED PROFESSIONALS
The $50 billion dollar Bernard Madoff Ponzi Scheme brought this subject to the public, but sadly, and very importantly, it also surfaced so-called experts that began advising victims on the recovery option under Internal Revenue Code Section 165 (c)(2). Adding to the tragedy of these losses is the fact that those same experts are supplying incorrect information. As an example: Stanford Law School and a former senior tax attorney for the IRS are both normally sources you can depend on for tax law advice. They are both valuable sources of information, but in trying to help victims of investment fraud, they recently published information that could cause more problems than they solve.
An article, Long And Winding Path To Tax Relief For Madoff Victims, appeared on accountingweb.com dated February 19, 2009. Stanford University provided information on the IRC 165 (c)(2) tax deduction, quoting a former IRS official. This article is an example of a long list of experts serving up misconceptions, serious omissions, wrong answers and lost opportunities. Add The Wall Street Journal, MSN, the New York Times and even the IRS to your list of experts providing incorrect information, and you begin to understand the seriousness of the problem.
FACTS – CURRENT TAX LAW HELPING VICTIMS OF INVESTMENT THEFT
Current law includes but is not limited to, the following facts:
IRC 165 (c)(2)
• Law was established in 1954 to help investment fraud victims recover a portion of their losses through tax benefits (much like that of natural disaster loss victims or casualty losses such as a destroyed automobile not covered by insurance). It was readdressed in 1984 by the Tax Reform Act, which did away with the 10% exclusion/$100 per item reduction.
• Deduction allows qualifying victims to take their total net loss against ordinary income in a single year.
• Deduction allows for the taxpayer to go back three years after declaring the loss in the “Year of Discovery” if a Net Operating Loss (NOL) remains, or, they can waive their right to go back, and carry the NOL forward up to 20 years.
• Deduction allows for up to a 20 year carry forward, with the exception of when the 3 year carry back is utilized, which subsequently creates the potential for a 23 year benefit.
• Losses in IRA and Pension Funds Do Not Qualify.
• The taxpayer must prove the investment was made and lost by reasons of theft as defined in the state where the transaction took place.
• Taxpayer must exhaust all reasonable means of recovery.
• Taxpayer must be able to prove privity (Private or joint knowledge of a private matter; especially: cognizance implying concurrence (Merriam-Webster) or in practical terms, there was a first hand relationship between the thief and the victim) in order to qualify. Ponzi scheme victims are generally not held to this requirement but that I’m aware, that exception is not written as fact.
• (Some) IRS agents consider any form of pending legal action (individual, class action, federal indictments, bankruptcy or receivership) as potential recovery and will deny a claim until such time as that open pursuit of recovery is resolved.
• IRS requires a victim to provide proof of cost basis (copies of checks, front and back, wire transfer confirmations, disbursements, withdrawals, recovery, etc.).
• Taxes on phantom income are recoverable in full but are only allowed to be carried back 3 years. The balance (NOL) can be carried forward up to 20 years.
FICTION – MISINFORMATION COMMONLY GIVEN TO THE PUBLIC
• Before a taxpayer can claim a deduction, they must first exclude 10% of their Adjusted Gross Income and $100 per item – Wrong. Although originally an aspect of the deduction, this exclusion was eliminated 25 years ago by the Tax Reform Act of 1984.
• 2 Year Net Operating Loss Carry Back – Common misconception. Other than in 2002, when Congress allowed an exception allowing for 5 years, the carry back has always been 3. The 2 year carry back does not apply to investment losses caused by theft.
• Up to 50% recovery of loss – Misleading. In my experience, taxpayers should expect to receive a total benefit between 10 – 20% of their loss. Although there may be an exception out there somewhere, I’ve never seen any victims receive even close to a 50% benefit.
• The deduction is taken in the year victims discover the money is gone – Maybe but not likely. Convincing the IRS of the right year to take the deduction is complicated. The big issue is the taxpayer having “exhausted all reasonable means of recovery”. The “year of discovery” determination will vary from agent to agent.
• The deduction is simple to obtain – Really? It takes a knowledgeable and experienced 165 tax preparer to guide both taxpayers and the IRS agents through this process. I promise you, you should be prepared to be fully prepared. Taxpayers should expect to be reviewed carefully.
FUTURE – NEW PROPOSED LEGISLATION
For some time, I have been trying to get Congress to see the need for changes in the law. The size of the Madoff ponzi scheme helped me with my mission to get congresses attention. In doing so, they are now discovering how prevalent investment theft and ponzi schemes are in America. Congressman Kendrick Meek of Florida’s 17th district moved quickly and proposed new legislation on February 24, 2009. I’m thrilled to see it happen, but it did not go far enough.
• Will allow a 10 year carry back (or length of time in fraudulent investment, whichever is lesser) on cost basis and taxes paid on phantom income verses the current carry back of 3 years. Given the fact that a great deal of injured investors are in the retiree/elder categories and have had little to no income over the last several years, this change will hopefully increase the chance of them reaching a year where significant taxes were paid.
• Proposes to provide assistance to individuals who contributed to charitable organizations. This is a new aspect to the law and it needs to be further examined in order to determine just who gets what benefits? It’s not clear on how this will work and I’ll have to wait for more details before I can comment.
• New legislation uses the word “estimate” verses “ascertained”. This may be a big help in the filing of the claims in a reasonable amount of time, but it is not definitive and more work needs to be done.
FUTURE – CONTINUED – QUESTIONS NOT ADDRESSED
• Will the complicated terms “Year of Discovery, Privity, Scienter, Cost Basis and Complete and Final Transaction” be defined in a way that makes it reasonable for the taxpayer to meet the requirements for filing? Regardless of what legislation is proposed or passed, unless these issues are defined in a way that tax payers, their tax professionals and the IRS alike can understand, little if any of this assistance will reach the intended recipients.
• Why is this limited to just ponzi schemes? Although certainly less publicized, other forms of investment fraud are still investment fraud and all qualifying victims should be given the same consideration,
• Will the new legislation actually limit the amount of time before a victim can claim the deduction and the IRS can take to approve it? The current process often takes so long that victims lose everything, including benefits, their homes and even their lives, before the help arrives.
• Will IRA and pension savings be added to the forms of acceptable losses/victims? A huge constituency of victims falls into this category and although technically they never paid taxes, they still worked hard for their money and would have paid them when the time arose. The money was withdrawn, the perpetrator was enriched and he or she should owe the taxes. Regardless of whether the IRS actually receives them, the victim should be entitled.
• Would a uniform tax rate potentially be the better and fairer way to go? Although the current proposed legislation goes far in trying to help, there are still a group of individuals that will be left helpless. As many of these individuals paid on average 15 – 20 % in taxes when the money was made, it doesn’t seem quite fair that they are penalized for having grown older or now having no income.
I’d start with definable (and reasonable) guidelines for tax payers and professionals. Next would be setting up fair opportunities for recovery across the board, regardless of tax bracket or age. And finally would be the creation of an organization, or an IRS qualifying exam, that sets the standards for professional services. Setting these guidelines and standards, much the same as what CPAs, doctors, attorneys, etc. must adhere to or lose their standing, would help satisfy the IRS that the claims are legitimate, would provide the relief that so far is nearly impossible to receive and insure that the professionals assisting these victims are qualified and making claims in good faith. By enacting legislation that gives the IRS authority to qualify those who represent taxpayers, they’d not only protect the victims, they’d protect all taxpayers against fraudulent or unworthy claims.
It was a breath of fresh air to finally see someone step up and try to help these people and I applaud Congressman Meek. He’s taken the first step, and with a few additions, he could make this law something to be proud of.
Join my voice and let Congressman Meek know that these other issues are important and will make a big difference.
Congressman Meek can be contacted at:
1039 Longworth House Office Building
Washington, DC 20515
Monday–Friday, 9 AM – 6 PM
Moira Souza Shiver
MSS Advocacy Group