Wednesday, March 18, 2009

New IRS Rules for Investors Defrauded by Madoff are of Little Comfort to Non-Profits

The Boston Globe reports on new IRS rules issued yesterday that aim to ease the pain for some victims of Bernard Madoff's swindle and other Ponzi schemes.  The rules allow victims to claim refunds on federal income taxes they paid on what turned out to be phantom investment gains.  Madoff has pleaded guilty to operating the largest Ponzi scheme in history, with a value estimated by prosecutors of up to $65 billion.  

The IRS rules do not promise full recovery of money lost to Madoff, but they should provide significant tax relief by allowing victims to treat much of the money they lost as "theft losses," rather than ordinary investment losses, for which deductions are capped at $3,000 per year.  The rules only apply to cases where specific frauds are alleged by authorities. According to the IRS, for the year in which a fraud is discovered, taxpayers can deduct 95% of their net investment minus any funds they recovered either from the perpetrator or insurance organizations such as the Securities Investor Protection Corp. Investors who put money into a fraud through a third party can deduct 75% of their net investment.  Importantly, the rules also allow investors to "carry back" the deductions on returns up to five years in the past, or to carry them forward 20 years, which should provide additional tax savings even for investors who parked money with Madoff for a decade or longer.

Doug Shulman, commissioner of the IRS, said in Senate testimony yesterday the new rules follow reports that thousands of investors were duped in dozens of fraudulent schemes. The Madoff case in particular "raises numerous tax and pension implications for the victims," he said.  However, not all victims will be helped by the changes, including nonprofit charities that are not subject to income taxes and do not benefit from tax breaks.  That includes some of Madoff's best-known Massachusetts investors, including the Robert I. Lappin Charitable Foundation in Salem, which has shut down and reorganized after sharp losses, and the Carl and Ruth Shapiro Family Foundation in Boston, which lost almost half its assets, or about $145 million.

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