Source: https://www.colemanlaw.com/tag/investment/
Timestamp: 2020-07-07 22:55:07
Document Index: 78005830

Matched Legal Cases: ['§ 165', '§ 7491', '§ 1221', '§ 165', '§165', '§ 67', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', '§ 6662', '§ 165', '§ 165', '§ 165', '§ 165', '§ 165', 'in casu', '§ 165', '§ 165']

investment Archives - Coleman Law Firm
Rolling Over Your 401(k): Should You Do It?
June 14, 2011 /in Estate planning Blog /by Jeff Coleman
When leaving a job, most people automatically transfer, or â€œroll,â€ their 401(k) accounts to an individual retirement account. Now, some companies are urging departing employees to leave their savings right where they are – and there could be some good reasons for doing so.
When an employee leaves a job, he or she is generally free to roll 401(k) money into an IRA; such accounts typically offer a much wider array of investment options. But while most employers have historically encouraged departing employees to make transfers, a growing number of companies now say they’re eager to keep former employees’ savings within their plans.
As baby boomers start to retire, â€œcompanies are realizing that participants with the biggest balances are going to be leaving the plan relatively soon,â€ says Katharine Wolf, a senior analyst at research firm Cerulli Associates. When assets decline, companies have less leverage to negotiate with plan administrators and fund companies for lower fees and unique investment options, she says.
In considering whether to keep money in a 401(k), departing employees must consider a range of factors, including fees, investment options and whether they may need protections from creditors or early access to their savings.
Participants in some 401(k) plans may discover that it’s cheaper to stay put. Often, plans with assets of $100 million or more receive access to low-cost investment products, including collective trusts, which resemble mutual funds but generally charge lower fees. (To find out what you’re paying in investment and administrative fees, ask your plan administrator or go to BrightScope.com, which rates plans.)
A 401(k) plan also may offer greater protection from creditors. While federal law shields the assets in 401(k) plans from a variety of claims, it only safeguards IRA assets in cases involving bankruptcies, says Ed Slott, an IRA consultant in Rockville Centre, N.Y.
Some states, including New York, have laws that provide greater protections for IRAs. But â€œthat’s not the case in every state,â€ cautions Mr. Slott.
After leaving a company at age 55 or older, a former employee also has leeway to take penalty-free withdrawals from that company’s 401(k) account. In contrast, those with IRAs generally must pay a 10% penalty on distributions taken before age 59[frac12], says Keri Dogan, a senior vice president at Fidelity Investments. (SMARTMONEY, MAY 11, 2011)
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https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png 0 0 Jeff Coleman https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png Jeff Coleman2010-12-07 00:41:172020-03-03 14:47:34LOSSES IN REAL ESTATE INVESTMENT TRUSTS (REITS)
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You should be particularly careful when considering transferring your money from one annuity to another. This procedure is often referred to as a 1035 or tax free exchange and is different from simply transferring money from one investment choice to another within the same annuity. Here, you actually exchange an existing variable annuity contract for a new annuity contract. There are legitimate reasons for a 1035 exchange; however, there are several potential downsides that your annuity salesperson may or may not know or remember to mention, including: 1) surrender charges for surrendering the first annuity; 2) possible subjection to a new and potentially longer surrender charge schedule for the new annuity; 3) ineligibility for a tax free transfer; 4) or higher fees for the new annuity.
In addition to the foregoing, numerous annuity beneficiaries have suffered tremendous losses at the hands of annuity salespeople who knowingly or negligently failed to address the potential detrimental effects of 1035 exchanges on the value of the initial annuity contract’s death benefit. Death benefits come in various forms, but most variable annuity contracts guarantee that the beneficiaries of the contract will receive, upon the annuitant’s death, the original amount invested in the annuity contract, adjusted for withdrawals. This provides peace of mind in that the beneficiaries will receive at least what was invested in the contract, regardless of investment performance. Some contracts offer beneficiaries a death benefit guaranteeing beneficiaries the higher of the original invested amount or the highest appreciated value of the annuity, determined at certain prescribed future dates. Regardless, fees are assessed for the death benefit feature, and the death benefit guarantee can be very important and powerful in the event of decreased investment values.
https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png 0 0 Jeff Coleman https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png Jeff Coleman2010-12-01 17:00:412020-03-03 14:50:00THINK TWICE BEFORE TRANSFERRING YOUR VARIABLE ANNUITY TO A DIFFERENT BROKERAGE FIRM OR ANNUITY COMPANY
Many investors are filing claims against UBS Financial Services and other major brokerage firms alleging that they were deceived as to the risks of investing in Lehman Brothers structured notes. Brokers pitched the notes, including notes with a principal protection feature, as conservative and safe investments with no risk and sold them to conservative investors seeking yield and preservation of investment principal. The true risks associated with these products were not disclosed by the brokers selling them, and investors were actually subject to significant amounts of risk. In fact, investors in the notes may lose all or a majority of their principal investments in the notes, as Lehman Brothers filed for bankruptcy protection on September 15, 2008.
https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png 0 0 Jeff Coleman https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png Jeff Coleman2010-11-30 22:26:072020-03-03 14:50:30LOSSES IN LEHMAN BROTHERS STRUCTURED NOTES
The Definition of Theft. 3
Examples of Conduct Giving Rise to Theft for Purposes of IRC § 165. 4
The Use of Judicial Estoppel to Support a Theft Characterization. 7
The Use of the Service’s Safe Harbor for Theft Loss Treatment for Losses Resulting From Ponzi Schemes. 9
1. Establishing the Loss as a Qualified Loss. 9
III. THE PRIVITY REQUIREMENT AND THE CORRESPONDING DENIAL OF THEFT LOSS TREATMENT FOR OPEN-MARKET TRANSACTIONS. 14
The Totality of the Facts and Circumstances Govern Reasonable Prospect of Recovery and Reasonable Certainty Tests. 28
Shifting the Burden of Proof on the Issue of Timing of the Theft Loss Deduction to the Service Under IRC § 7491. 34
The classic Ponzi scheme may soon be renamed the Madoff scheme, simply by virtue of the massive amounts of monies, an estimated $50 billion, invested with Madoff. It is now known that Bernie Madoff, like his famous predecessor, Charles Ponzi, used monies given to him by new investors to pay prior investors promised returns on their earlier investments. Madoff, like Ponzi, and also allegedly like Arthur Nadel and others, robbed Peter to pay Paul. Their massive scams wrongfully deprived thousands of investors of billions of dollars.
For individual investors, the Internal Revenue Code (IRC) generally treats investment losses as capital losses, deductible only to the extent of $3000 in excess of the capital gain experienced by the taxpayer for the year in question.[3] Even though the excess capital loss may be carried forward to later tax years, the deductibility of these losses is still subject to the same limitations. [4] In addition, because a capital gain is only experienced upon the sale or exchange of property (see IRC § 1221), capital gains are less likely to be recurring income. Thus, there is the potential that a significant loss suffered by a defrauded investor may never be utilized in the investor’s lifetime.
Theft losses, on the other hand, are not limited in the same manner that capital losses are limited. More importantly, a theft loss can be used by individuals as a deduction against ordinary income such as wages or interest income to the extent that the theft loss is not covered by insurance or otherwise.[5] In addition, in Revenue Ruling 2009-9, 2009-14 I.R.B. 735, issued March 17, 2009, the Internal Revenue Service (Service) announced that theft losses resulting from investment transactions are deductible under IRC § 165(c)(2) rather than (c)(3). As such, they are not subject to the limitations of IRC §165(h), limiting certain losses to the excess of $100 and 10% of adjusted gross income. Nor, announced the Service, are theft losses resulting from investments subject to the limitations on itemized deductions found in IRC §§ 67 and 68.
Ordinary income, of course, is more likely to be recurring, substantial, and taxed at higher marginal rates. Thus, a theft loss deduction that can be deducted against ordinary income can give the victim of a fraudulent investment scheme greater, more immediate relief than can a deduction for a capital loss. But, is it proper under federal income tax law, to treat an investment loss as a theft loss? The answer for victims of Ponzi schemes is often yes. For victims of other kinds of investment loss caused by securities fraud or other wrongdoing, theft loss treatment might be available under certain circumstances.
The court in Edwards v. Bromberg, 232 F. 2d 107 (5th Cir. 1956) provided what is the most often-cited definition of theft for purposes of IRC § 165, as follows:
The broad approach of the Bromberg court to the definition of theft is reflected in the Treasury Regulations promulgated under IRC § 165, deeming theft to include, but not be limited to, larceny, embezzlement, and robbery.[7]
Whether a theft has occurred depends upon the law of the jurisdiction where the loss was sustained.[8] Either state or federal law can provide the requisite basis for establishing a theft loss to the extent applicable to the conduct at issue in the jurisdiction where the theft occurred.
And the record before us establishes that Livingstone’s fraud in obtaining money from petitioners brings this case within the applicable Florida criminal statute in respect of obtaining money by false representations or pretense, Fla. Stat., sec. 811.021(s), as well as within the provisions of the United States Code which makes it a crime to use the mails to defraud, 18 U.S.C., sec. 1341. The crime under either Florida or Federal law was a â€˜theft’ within section 165 of the Internal Revenue Code.[9]
Furthermore, it is unnecessary that the perpetrator of the theft be convicted or even charged with theft.[10]
Examples of Conduct Giving Rise to Theft for Purposes of IRC § 165.
The Bromberg Court’s inclusion of any other form of guile within the ambit of theft for purposes of § 165 is certainly broad enough to include the Ponzis, the Madoffs, and the Nadels. The court’s emphasis, in particular, on swindling, false pretenses, and any other form of guile potentially includes securities fraud within its scope. The Service acknowledged this possibility in Chief Counsel Advice 200811016.[11]
Chief Counsel’s Office opined that these facts establish that a theft occurred, notwithstanding the structure of the transactions.
In Revenue Ruling 77-18, 1977-1 C.B. 46, the Service similarly concluded that a theft loss occurred under circumstances in which a taxpayer received shares of stock in a company (X Company) in exchange for his shares of stock in another company (G Company) pursuant to a merger agreement between the two companies. Soon thereafter, X Company filed for bankruptcy. The bankruptcy trustee reported that the primary goal of the fraud participants was to inflate . . . the market price of X’s stock . . . by reporting nonexistent income and assets on the corporate books and failing to record liabilities.[15]
The law of the state in which the taxpayer in Revenue Ruling 77-18 resided included within its definition of theft, the obtaining of property by false pretenses. Thus, the Service concluded as follows:
A number of states include the obtaining of property by false pretenses within their definition of theft.[17] Thus, circumstances that give rise (or would give rise) to a charge of theft by false pretenses are favorable to a characterization of theft under IRC § 165.
Circumstances resulting in criminal charges for the sale of unregistered securities can also give rise to a theft characterization under IRC § 165. In Vietzke v. Commissioner, 37 T.C. 504 (1961), the Tax Court upheld the taxpayer’s theft loss treatment for funds invested in what was purported to be an insurance company directly through the company principals. Contrary to the representations in the prospectus, the stock and the company were not properly registered. The company principals were criminally indicted on charges of violating Indiana Securities Law by selling unregistered securities through an unregistered agent. The Tax Court rejected the Service’s claim that the company principals lacked criminal intent, finding as follows:
Interestingly, the Tax Court in Vietzke did not rely on the elements of the crime with which the principals were charged (i.e., the sale of unregistered securities) in concluding that the taxpayer had suffered a theft loss. Nor did the Tax Court rely on the statutory crime of theft under Indiana law, having found none denoted theft per se. Instead, the Tax Court pointed to the broad definition of theft established by the Bromberg Court.â€[19] The court was simply satisfied that, based on the facts, the principals acted with a criminal intent to deprive the taxpayer/investor of his funds.
The Service agreed that churning of, and unauthorized transactions in, the taxpayer’s brokerage account by his broker constituted theft under the applicable state law for purposes of IRC § 165 in Jeppsen v. Commissioner, 70 T.C.M. (CCH) 199 (1995).[20] There, the taxpayer, a carpet installer, invested monies he was saving with a nationally-recognized brokerage firm. The broker (i) falsified the taxpayer’s new account documents, labeling him an experienced investor, (ii) engaged in unauthorized transactions, including purchasing stocks on margin, and (iii) churned the taxpayer’s account. Although finding the conduct constituted theft, the court nonetheless denied the theft loss deduction for the year in which the taxpayer claimed it as, in that year, the taxpayer was exploring the possibility of filing a lawsuit against the brokerage firms involved. Thus, the taxpayer’s claim of a theft loss was premature, as he retained, and was pursuing, a reasonable prospect of recovering his loss.[21]
The Use of Judicial Estoppel to Support a Theft Characterization.
The test for theft characterization under IRC § 165, as previously explained, is not dependent upon a criminal indictment or conviction. Rather, the test depends upon whether the conduct evidences a criminal appropriation of another’s property by theft, false pretenses, and any other form of guile . . . without regard to the exact nature of the crime . . . .[22] Thus, there have been cases in which the Service and courts have allowed theft loss treatment even in the absence of a criminal indictment or conviction of the perpetrators.[23] Nonetheless, a criminal charge or conviction is helpful in supporting the specific intent required of the perpetrator.[24]
When there is a criminal conviction of, or a guilty plea from, the perpetrator of the fraud, the defrauded investor should be able to assert that the Service is judicially estopped from contesting the characterization of the investment loss as a theft loss if the federal government has successfully prosecuted the perpetrator for the conduct at issue. Judicial estoppel prevents a party from asserting a position in a legal proceeding that is contrary to a position previously taken in the same or earlier proceeding. [25] The doctrine of judicial estoppel is similar to the doctrines of res judicata and collateral estoppel, which prevent parties from relitigating issues decided in prior proceedings by a court of competent jurisdiction.[26] However, [j]udicial estoppel focuses [only] on the relationship between a party and the courts and seeks to protect the integrity of the judicial process by preventing a party from successfully asserting one position before a court and then asserting a contradictory position before the same or another court merely because it is now in that party’s favor to do so.[27]
The Use of the Service’s Safe Harbor for Theft Loss Treatment for Losses Resulting From Ponzi Schemes.
On March 17, 2009, the Service issued Revenue Procedure 2009-20,[30] creating an optional safe harbor for treatment of certain investment losses as theft losses (think Madoff). Under this Procedure, if the taxpayer elects the safe harbor, a theft loss is deemed to occur. The deemed theft loss, called a qualified loss, occurs when a taxpayer has invested in a specified fraudulent arrangement and one or more of the perpetrators has been criminally charged with one or more crimes that would meet the definition of theft for purposes of IRC § 165, provided certain other conditions are satisfied. This safe-harbor treatment is available to losses for which the discovery year, as specifically defined in the Procedure, is 2008 or later.[31]
1. Establishing the Loss as a Qualified Loss.â€
First, to utilize the safe harbor, the taxpayer must have invested in a
specified fraudulent arrangement.â€ A specified fraudulent arrangement is, generally speaking, a Ponzi scheme.[32]
Second, to utilize the safe harbor, one or more of the perpetrators must have been charged, criminally, by indictment, information, or complaint (not withdrawn or dismissed) under state or federal law. The criminal charges, as previously mentioned, must constitute theftâ€ under the law of the jurisdiction in which the theft occurred, consistent with the existing case law governing this issue.[33]
It is worth noting that there are a number of reasons criminal charges may not be filed against the perpetrator, such as death of the perpetrator, a disinclination to prosecute while SEC civil investigations are ongoing, or the small size of the fraudulent scheme in comparison to other schemes given limited prosecutorial resources. The conduct of the perpetrator may nonetheless constitute theft under the law of the applicable jurisdiction, and the victims may still qualify for theft lossâ€ treatment for their investment losses, just not under the safe harbor of Revenue Procedure 2009-20.
The third requirement of a qualified lossâ€ under the safe harbor applies only if the criminal charges are by complaint versus indictment or information. If the charges are by complaint (versus indictment or information), then one of the following three factors must also be present: (i) the complaint must allege an admission by the lead figure,â€ or, (ii)a receiver or trustee must have been appointed for the specified fraudulent arrangement or, (iii) the assets of the specified fraudulent arrangement must have been frozen.[34] The reason for this added requirement for criminal charges by complaint versus indictment or information is the lesser standard of probable cause generally applicable to criminal charges by complaint.
In addition, the taxpayer must have clean hands.â€ If the taxpayer had actual knowledge of the fraudulent nature of the arrangement prior to its public outing,â€ the taxpayer cannot utilize the safe harbor. Nor is the safe harbor available to investors in tax shelters (as defined in IRC § 6662(d)(2)(C)(ii)) or to those who invested in the fraudulent arrangement through a fund or other entity.[35] This latter restriction retains the Service’s historic hostility to granting theft lossâ€ treatment to defrauded investors who were not in privity with the perpetrator of the fraud.
Under IRC § 165(e), all theft losses are treated as sustained during the taxable year in which the taxpayer discovers the loss.[36] Discovery of the theft, whether from a fraud, embezzlement, or other kind of misappropriation of the taxpayer’s property, has not, however, ended the query. Taxpayers also have had to grapple with the general limitation applicable to all losses subject to IRC § 165(a). That general limitation has required consideration of whether there exists a reasonable prospect of recoveryâ€ from insurance or otherwise.[37]
If a reasonable prospect of recovery exists as to part of a theft loss, then a deduction as to that part of the loss is unavailable until the year in which it can be determined, with reasonable certainty, that no recovery or reimbursement will be received.[38] These two issues – – whether a reasonable prospect of recoveryâ€ exists and whether it can be ascertained with reasonable certaintyâ€ that no recovery or reimbursement will be received â€“ have generated much litigation, because they have are based upon the facts and circumstances of each case.
For victims of Ponzi schemes who choose the safe harbor provisions of Revenue Procedure 2009-20, the uncertainty concerning the timing of the deduction is eliminated. Under the Procedure, the year of discovery of the loss of a qualified investment,â€ is also the year that the amount to be deductedâ€ can be deducted. The discovery yearâ€ is the year in which occurs the previously-described criminal indictment, information, or complaint. [39]
The amount deductible in the discovery year is determined by simply applying one of two fixed percentages to the qualified investment.â€ Subject to certain exclusions, qualified investmentâ€ generally means all amounts (cash or basis of property) invested in the fraudulent arrangement, plus income from the arrangement previously included in income for federal tax purposes over amounts of cash or other property withdrawn from the arrangement, whether designated principal or income.[40]
If recovery is not pursued against potential third parties,â€[41] ninety-five percent (95%) of the qualified investment is considered in the year of discovery. If recovery is being, or intended to be, pursued from potential third parties,â€[42] then seventy-five percent (75%) of the qualified investmentâ€ is considered in the year of discovery. The product of whichever of the foregoing formulas applies is then reduced by the following: (i) any actual recovery, (ii) any actual or potential claim for reimbursement under the qualified investor’s insurance policy, (iii) any actual or potential claim for reimbursement under contractual arrangements (other than insurance), and (iv) any actual or potential insurance recovery from SIPC.[43] The resulting amount is then available as a deduction in the year of discovery.[44]
If a taxpayer electing safe-harbor treatment later recovers amounts in excess of the amount of qualified investment deducted under the safe harbor, that excess amount is includible in income under the tax benefit rule. Likewise, an additional deduction may be available in a later year provided that the additional deduction has been determined, with reasonable certainty, to be non-recoverable.[45] Unfortunately, as previously mentioned and as discussed further below, the application of the determined with reasonable certaintyâ€ test is fact-intensive and troublesome. Fortunately, under the safe harbor, the taxpayer escapes this troublesome query for much of the theft loss.
In summary, investment fraud has dire consequences for those defrauded. It can mean the loss of a lifetime of savings, the burden of unpaid bills, and the prospect of working well beyond an age of physical capability. Whether it occurs through the unauthorized churning of an investor’s account, the presentation of fraudulent financial statements, or the stealing from Peter to pay Paulâ€ found in the classic Ponzi scheme, it is right for the Service to provide investors robbed in this fashion the same relief provided other victims of theft. Unfortunately, many more situations fall outside of the safe harbor of Revenue Procedure 2009-20 than fall within it. It is incumbent upon the taxpayer taking a theft lossâ€ resulting from an investment arrangement, whether within or without the safe harbor, to be sure that the theft lossâ€ deduction is well supported.
III. THE PRIVITY REQUIREMENT AND THE CORRESPONDING DENIAL OF THEFT LOSSâ€ TREATMENT FOR OPEN-MARKET TRANSACTIONS.
The court in Edwards v. Bromberg, 232 F. 2d 107, articulated the most frequently cited definition of theftâ€ for purposes of § 165. The Bromberg court’s broad definition of theft, intended to cover and covering any criminal appropriation of another’s propertyâ€ is still cited.[47] Even the Service continues to cite the broad Bromberg definition of theft.â€[48] Yet, in application, there are seemingly illogical inconsistencies that suggest a hostility to providing a theft loss deduction to investors who have been victimized by fraud committed by the principals of companies in which they invested, but with whom they did not deal directly.
The taxpayer, however, purchased only a small percentage of his Equity Funding stock through the Company’s employee stock option plan. The bulk of his Equity Funding stock was purchased on the open market. As to this stock, the Tax Court upheld the Service’s denial of theft lossâ€ treatment, reasoning that the state’s criminal theft statute required that there be an appropriation by the defrauder of the victim’s property.â€[51] This misappropriation by the defrauder of the victim’s property could only occur, concluded the Tax Court, if there was privity between the taxpayer and the defrauder as to the stock purchased. Finding no privity between the Equity Funding officers and the taxpayer with respect to the stock the taxpayer purchased on the open market, the Tax Court refused to find a theft,â€ notwithstanding that the taxpayer relied on the same fraudulent representations of the Equity Funding officers with respect to both the stock acquired through the Company’s employee stock option plan and the stock acquired on the open market.
The imposition of a privity requirement originates from the Service’s and the courts’ interpretation of the specific intentâ€ prerequisite for criminal theft, appropriation of another’s property by false pretenses, and other conduct amounting to theft under the law of many states. If there is no privity between the defrauded investor and the defrauder, reason the courts, then the defrauder could not have specifically intended to defraud the investor.[52] This constrained approach is illogical when the investor can show reliance on fraudulent representations and omissions of the issuer of the securities in purchasing the securities, even though the securities are purchased on the open market.
In fact, in some cases, it is clear that the court denied theftâ€ characterization only after analyzing whether the evidences supported the taxpayer’s reliance on the criminal conduct of the defrauders in purchasing the securities. In Paine v. Commissioner, 63 T.C. 736 (1975), the Tax Court denied theft loss treatment for shares in Westec Corp. purchased by the taxpayer on the open market. Subsequent to the taxpayer’s purchase, the principal officers and employees of Westec were indicted for violations of federal securities and mail fraud statutes for falsely representing acquisitions, transactions, and revenue growth with respect to the company. Bankruptcy followed. The taxpayer argued that Westec’s fraud caused him to purchase the Westec stock at artificially-inflated prices, thereby constituting a theft to that extent.[53]
The Tax Court in DeFusco recognized that the taxpayer suffered a financial disaster.â€ The Equity Funding losses nearly wiped out the taxpayer’s entire life savings.[56] The Court was willing to consider disasterâ€ treatment, i.e., treatment as a theft under IRC § 165(c), only for those losses resulting from the stock acquired through the employee stock option program. Yet, the same fraudulent representations were made as to both the stock optionâ€ stock and the open marketâ€ stock. The same losses were incurred for both the stock optionâ€ stock and the open marketâ€ stock. The only difference was in the form taken by the taxpayer’s purchase of the Equity Funding stock.
The result in DeFusco is at odds with the directive found in the Treasury Regulations promulgated under IRC § 165 which provides that [s]ubstance and not mere form shall govern in determining a deductible loss.â€[57] While a substance over formâ€ doctrine as to the tax treatment of transactions has been used against taxpayers by the Service and recognized by the courts since the Supreme Court’s decision in Gregory v. Helvering, 293 U.S. 465 (1935), taxpayers have not been as fortunate in their attempted use of this doctrine. Instead, taxpayers, once having chosen the form of their transaction, are generally stuck with the tax consequences of the chosen form.[58] Nonetheless, there are instances in which the taxpayer has prevailed by using a substance-over-form argument.
For example, in Estate of Durkin v. Commissioner, 99 T.C. 561, 575 (1992), the Tax Court stated that [r]esort to substance is not a right reserved for the Commissioner’s exclusive benefit, to use or not use â€“ depending on the amount of tax to be realized.â€[59] Courts have recognized taxpayers’ right to use substance over form in the absence of dishonesty, inconsistency in tax treatment, and unjust enrichment.[60] In the context of theft losses, there is no taxpayer dishonesty, no unjust enrichment (theft losses are not deductible if they are reimbursed through insurance or otherwise), and little opportunity for inconsistent tax treatment. There are only individuals who suffer some calamity as the result of someone else’s criminal conduct.
The Tax Court in Vietzke v. Commissioner, 37 T.C. 504 (1961), looked at the substance of what occurred and found a theftâ€ of monies invested by the taxpayer in a company established by perpetrators of a fraud. The perpetrators, also the principals of the company, proceeded to use the company’s funds for their own personal use. Rejecting the Service’s contention that the theft was actually from the company and not the taxpayer, the Tax Court found as follows:
The Service’s position, in Vietzke was, in effect, a privityâ€ argument. The Service argued that the theft did not occur directly from the taxpayer but, instead, through the corporation. The Tax Court rightfully declined to elevate the form of the transactions above what occurred in substance, i.e., the monies invested in the company by the taxpayers were wrongfully used to enrich the principals of the company.
The Tax Court, in Vietzke, recognized that a company can be wrongfully used to enrich its principals and that such use constitutes a theftâ€ from investors. Despite this recognition, neither the Service nor the Tax Court has applied this principle to investments purchased on the open market, even when the companies’ principals or executives have intentionally misrepresented the companies’ financial conditions for the purpose of maintaining an inflated stock value and enriching themselves. The reasoning for precluding a theftâ€ characterization in all cases in which the investor purchases the security on the open market is weak.
The Service’s position on the use of a theftâ€ characterization for open market transactions is unambiguously articulated in IRS Notice 2004-27, 2004-16 IRB (March 25, 2004). The holding of that Notice reads as follows:
In short, if a company’s principals or executives, through fraudulent or other wrongful conduct, may have caused a decrease in the value of stock purchased on the open market, the purchaser cannot characterize the decrease in value as a theftâ€ under Section 165.
To get to its seemingly blanket prohibition on theft lossâ€ characterization for investments purchased on the open market, the Service, in Notice 2004-27, simply concludes that the courts have consistently disallowed theft loss deductions relating to a decline in the value of the stock that was attributable to corporate officers misrepresenting the financial condition of the corporation, even when the officers were indicted for securities fraud or other criminal violations.â€[65] Yet, even the Paine v. Commissioner[66] case cited by the Service in Notice 2004-27, a case that involved criminal misrepresentations of the financial condition of a publicly-traded company by its principals, fails to support the Service’s conclusion.
Initially, the Paine Court pointed to the difficulty the taxpayer had in satisfying the specific intentâ€ requirement of the applicable state law’s concept of theft,â€ requiring that the perpetrator have the specific intent to appropriate the victim’s property. Presumably, if the taxpayer could have proven that the perpetrators’ specifically intended to enrich themselves at the expense of the investors in their publicly-traded company, the taxpayer would have been able to satisfy this element. Thus, it was not the existence of the transaction on the open market, per se, which precluded a theftâ€ characterization, but the inability to prove that the taxpayer was among the perpetrator’s intended victims.[67]
What is missing from both the holding and the analysis of the Tax Court in Paine is any hint of a per se prohibition on characterizing the loss of money invested by purchasing stock on the open market as a theftâ€ regardless of the circumstances.
Similarly, in MTS International, Inc. v. Commissioner, 169 F. 3d 1018 (6th Cir. 1999), the other significant case cited by the Service as support for its position, there is neither a holding nor an analysis concluding with a per se ban on theftâ€ characterizations for stock purchased on the open market. Instead, as in Paine, the court pointed to the lack of evidence establishing the taxpayer’s reliance on the fraudulent misrepresentations in denying a theftâ€ characterization, stating as follows:
The court’s denial of theft loss treatment, then, was not based on the existence of a purchase on the open market; rather, the court’s denial was based on the taxpayer’s inability to satisfy the relianceâ€ element of the law of the jurisdiction’s concept of theft.â€
As the foregoing cases and cited Treasury Regulation illustrate, open market purchases of stock in companies whose principals criminally misrepresent the companies’ financial condition or otherwise criminally use the companies to enrich themselves, create problems of proof with respect to intent, reliance, and causation. They, however, do not logically support a per se ban on theft lossâ€ treatment for investments purchased on the open market based on the lack of privity between the investors and the investment or fraud perpetrators. In the context of open market transactions, issues of intent, reliance, and causation should not bar a theft loss deduction provided the taxpayer has established some causal connection between the securities fraud and the loss in value of his investment.[72] Difficulties in proof surely will exist. These difficulties, however, should not deny the taxpayer the right to a lawful ordinary, theft lossâ€ deduction for a loss caused by the criminal wrongdoing of another.
IRC Section 165(a) articulates the general rule for the timing of a deduction for losses allowable under Section 165, permitting a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise.â€ Under the general rule applicable to all losses deductible under Section 165 (i.e., certain business losses, certain investment losses, and certain casualty and theft losses), a loss is sustainedâ€ when it is evidenced by closed and completed transactions and when it is fixed by identifiable events.[73] For example, the dousing of a fire pretty much fixes the event of a casualty loss resulting from a fire. However, in the case of theft losses resulting, for example, from fraud or embezzlement, often the loss is not discovered until long after the perpetrator has successfully misappropriated the victim’s property.
Because a loss allowable as a deduction under Section 165 is allowable only for the taxable year in which . . . [the loss] is sustained,â€ accurately determining the year in which the loss is sustained is crucial.[74] For this reason, in 1954, Congress enacted IRC § 165(e) to provide that any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers the loss.â€[75] Prior to the enactment of IRC Section 165(e), taxpayers were denied theft loss deductions for thefts that were not discovered until years after the actual theft or embezzlement. By then, the running of the statute of limitations for amending the victim’s tax return for the year in which the theft or embezzlement or fraud occurred precluded the taxpayer from ever taking the loss.
Section 165(e), providing that a theft loss is sustained in the year it is discovered, however, does not trump the requirement under Section 165(a), which includes consideration of prospects of recovery.â€[76] That is, the Service will not allow the deduction of a loss if the taxpayer is pursuing recovery or reimbursement of the loss from other sources. For theft losses, then, a loss is sustained when it is discovered. Even after discovery of the loss, however, it is not sustained if there is a claim for reimbursement as to which there is a reasonable prospect of recovery. If the loss (or a portion of the loss) is subject to a claim with respect to which there is a reasonable prospect of recovery, then the loss (or that portion of the loss) is not sustained until the taxable year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received.â€[77]
If there is no claim with a reasonable prospect of recovery in the year of discovery of the theft loss, then the year of discovery is the year of the deduction. If, however, there is a claim with a reasonable prospect of recovery, then the proper year of deduction is the year in which it can be determined with reasonable certainty that the loss is non-recoverable, a determination which can be made partially in one year and partially in another year if the reasonable certainty testâ€ is not satisfied in one year as to all of the loss.[80] The questions of whether there exists a claim with a reasonable prospect of recoveryâ€ and when a recovery, if any, will be forthcoming as determined with reasonable certaintyâ€ are, unfortunately, highly fact-intensive issues.[81] They are, nonetheless, very important issues to get right.â€
The foregoing result may sound too harsh to occur in actuality, but this was exactly the situation in which the taxpayers in Wisnewski v. United States, 79-2 USTC (CCH) ¶ 9496 (N.D. Tex. 1979) found themselves. There the taxpayers discovered a loss deductible under IRC § 165(a) in 1968, and they filed suit against the alleged perpetrator in that same year. The litigation settled by consent decree in 1972, and the taxpayers claimed their losses, which proved uncollectable, as reasonably ascertainable, in that year, 1972. In the latter part of 1975, the Service examined the taxpayers’ 1972 return and disallowed the loss, contending that the amount of the loss was ascertainable with reasonable certainty in an earlier year, 1971, a year now time-barred by the general three-year statute of limitations for amending tax returns. The court upheld the Service’s position, noting that, by 1971, the alleged perpetrator had disposed of all of his assets that were not exempt from creditors and that the taxpayers had been advised of this fact by their attorney, thereby exemplifying the importance of getting the timingâ€ issue correct.
The Totality of the Facts and Circumstances Govern Reasonable Prospect of Recoveryâ€ and Reasonable Certaintyâ€ Tests.
At least the foregoing guidance is some guidance, even though the examples of facts giving rise to a determination with reasonable certaintyâ€ of no recovery seem fairly obvious. The settlement or adjudication of a taxpayer’s pending litigation to recover a theft loss from the perpetrator allows for a determination of the amount of the unrecoverable loss with enough certainty to allow for a deduction. A taxpayer’s release or abandonment of a pending claim does likewise.
Less obvious are those situations where a court has appointed a receiver or trustee with respect to the assets of the perpetrator of the fraudulent scheme. A case in point is Kaplan v. United States, 2007 WL 2330841 (M.D. Fla. Aug. 15, 2007), a case in which the taxpayers, a husband and wife, lost millions of dollars in a Ponzi scheme. As previously discussed, for victims of certain Ponzi schemes that elect and qualify for the safe harbor treatment of Revenue Procedure 2009-20, the timing issuesâ€ associated with determining the year in which the losses are deductible are mostly moot. The safe harbor applies fixed percentages of 75% or 95%, depending upon the existence of certain claims for recovery, to the qualifying losses to arrive at the amount deductible in the year of discovery of the loss, as defined in the Revenue Procedure. For cases falling outside the safe harbor, Kaplan illustrates the frustration associated with application of the timing issues.â€
The perpetrator in the Kaplan case ran a Ponzi scheme from 1986 until May of 2001. The taxpayers in Kaplan invested over $5 million with the perpetrator from 1992 through October of 2000. Prior to discovery of the Ponzi scheme, the Kaplans reported on their tax returns millions more in income purportedly earned (but not distributed) on the monies they had invested. Income such as that purportedly earned by the Kaplans on their monies invested is often referred to as phantom incomeâ€ in the context of Ponzi schemes. In 2001, the perpetrator filed for bankruptcy. In 2002, the perpetrator pled guilty to fifteen felony counts and admitted to operating a Ponzi scheme.
Thus, after years of court and administrative proceedings, the Kaplans learned that their theft lossâ€ deduction was not quite ripe.
The Kaplans’ disappointment was not over. The court also addressed their claim for a theft loss for the income purportedly earned on their investment, i.e., the phantom income.â€ This incomeâ€ was reinvested and thus not distributed to them. They did, however, report the incomeâ€ on their tax returns over the years, and they did pay taxes on the income.â€ The Service argued that there was no â€œincomeâ€ because the investment was a Ponzi scheme and there was thus no income to steal. The court agreed with the Service, notwithstanding that the taxpayers produced an IRS Memorandum addressing this particular Ponzi scheme that concluded that investors who reported income, dubbed â€œphantom income,â€ could take a theft loss for that â€œphantom incomeâ€ under certain circumstances.[88]
https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png 0 0 Jeff Coleman https://www.colemanlaw.com/wp-content/uploads/2015/12/logo.png Jeff Coleman2010-11-30 22:13:472020-03-03 14:51:01IRS LOSS TREATMENT FOR CERTAIN INVESTMENT LOSSES