Tax Deduction Available for Ponzi Scheme Related Theft

The current tax season brings some small consolation to victims of Ponzi schemes and certain other financial fraud, with the Internal Revenue Service (“IRS”) allowing duped investors to obtain partial relief in the form of a theft loss tax deduction.  Internal Revenue Code (“IRC”) 165(a) provides that a theft loss incurred in a transaction entered into for profit and sustained during the taxable year is deductible to the extent it is not compensated by insurance or otherwise recovered.

For federal income tax purposes, “theft” covers “any criminal appropriation of another’s property to the use of the taker, including theft by swindling, false pretenses and any other form of guile.”  In order to qualify as a theft loss, the taxpayer must demonstrate that the act was done with criminal intent, but does not require a conviction.  The IRS describes that a Ponzi scheme fits this definition because the perpetrator specifically intended to, and did, deprive the investor of money by criminal acts.  Revenue Ruling 2009-9 addresses the tax treatment of losses from criminally fraudulent investment arrangements that take the form of Ponzi schemes.  In contrast, a loss sustained on an open market stock investment, even if the loss is attributable to fraudulent activities of the corporation’s officers or directors, is a capital loss.  The IRS describes that this is because the officers or directors did not have the specific intent to deprive the shareholder of money or property.  This related article describes how to calculate a theft loss for a Ponzi scheme.

Of course, it is certainly better to avoiding investing in a Ponzi scheme altogether than to later obtain a theft loss deduction for tax purposes.  This additional article includes information on how to avoid a Ponzi scheme.

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