Court Opinion

ID: 9960228
Source: CourtListenerOpinion
Date Created: 2024-04-15 19:02:32.291588+00
Date Added: 2024-06-11T08:19:19.138031
License: Public Domain

United States Tax Court

                          T.C. Memo. 2024-43

   CHRISTOPHER S. PASCUCCI AND SILVANA B. PASCUCCI,
                      Petitioners

                                   v.

           COMMISSIONER OF INTERNAL REVENUE,
                       Respondent

                              —————

Docket No. 2966-19.                                 Filed April 15, 2024.

                              —————

             On Schedule A, “Itemized Deductions”, of their 2008
      tax return, Ps claimed an I.R.C. § 165 theft loss deduction
      of $8.2 million and a resulting net operating loss (“NOL”);
      and for tax years 2005, 2006, and 2007, Ps claimed
      tentative refunds for carrybacks of the 2008 NOL. The
      claimed theft loss resulted from the decline in cash value
      of separate accounts for Ps’ variable life insurance policies
      held with two insurance companies. The decline occurred
      after the unraveling of a Ponzi scheme perpetrated by
      Bernard L. Madoff in 2008. R disallowed the theft loss
      deduction and the NOL carrybacks, and R accordingly
      determined deficiencies for 2005, 2006, and 2008.

            Held: Ps did not own the assets in the separate
      accounts at the time of the theft by Mr. Madoff.

            Held, further, Ps are not entitled to a theft loss
      deduction under I.R.C. § 165 nor to the NOL carrybacks.

                              —————

Kendall C. Jones and Mary E. Monahan, for petitioners.

Deborah Aloof, Rachel L. Gregory, and Nathaniel C. Smith, for
respondent.

                           Served 04/15/24
                                             2

[*2]                       MEMORANDUM OPINION

       GUSTAFSON, Judge: This is an income tax deficiency case
brought pursuant to section 6213(a), 1 in which petitioners, Christopher
S. and Silvana B. Pascucci, 2 challenge the determination by the Internal
Revenue Service (“IRS”) to disallow the Pascuccis’ claimed theft loss
deduction for the 2008 tax year (and the resulting loss carrybacks that
they claimed for tax years 2005 and 2006). By joint motion of the
parties, this case was submitted fully stipulated under Rule 122. The
facts stated below are based on the pleadings, the stipulations, and
exhibits to which the stipulations are attached. For the reasons stated
below, we hold that the IRS properly disallowed the claimed theft loss
deduction because the Pascuccis did not own the assets that were stolen
in 2008 as part of the Ponzi scheme carried out by Bernard Madoff.

                                      Background

       When the Pascuccis timely filed the petition commencing this
case, they resided in New York.

The variable life insurance policies

       Mr. Pascucci owned, either directly or through trusts, 16 flexible
premium variable life insurance policies (“Policies”) on December 11,
2008. Seven of the Policies—which Mr. Pascucci had owned since
1997—were with Security Equity Life Insurance Co. (“SELIC”), and the
other nine—owned by Mr. Pascucci since 2001—were with General
American Life Insurance Co. (“GenAm”). Both GenAm and SELIC were
acquired by Metropolitan Life Insurance Co. (“MetLife”) before the 2008
collapse of the Madoff Ponzi scheme (described below).

        1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (“Code”), as in effect at the relevant times, regulation references
are to the Code of Federal Regulations, Title 26 (Treas. Reg.), as in effect at the relevant
times, and Rule references are to the Tax Court Rules of Practice and Procedure.
A citation of a “Doc.” in this Opinion refers to a document as numbered in the Tax
Court docket record of this case. Dollar amounts are rounded.
         2 Mr. and Mrs. Pascucci filed joint tax returns for the years at issue; the notice

of deficiency underlying this case was issued to both of them; and both are petitioners
here. However, it was Mr. Pascucci who engaged in the transaction at issue here, so
this opinion refers primarily to him.
                                        3

[*3] The SELIC Policies

      On or around April 22, 1997, SELIC issued a private placement
memorandum (“SELIC PPM”) 3 that offered recipients the option to
purchase a variable life insurance certificate that would provide them
the opportunity to acquire insurance on the life of a person in whom they
had an insurable interest. Premiums paid would be held in one or more
separate accounts. The first page of the memorandum stated: “The
assets of each Separate Account are owned by SELIC but are kept
separate from the assets in SELIC’s general accounts and any of its
other separate accounts.” To the same effect, a section of the
memorandum entitled “The Separate Accounts” provided: “For State
law purposes, each Separate Account is treated as a part or division of
SELIC. . . . SELIC owns the assets of each Separate Account.”

      The Insurance Account Value under the Certificate varied (unlike
a conventional life insurance policy, which has a predictable cash value
and a fixed death benefit), and the Certificate Holder bore the entire
investment risk. The Certificate included no minimum guaranteed
Investment Account Value for the premiums paid.

       MetLife acquired SELIC in 1999.        After that acquisition,
Mr. Pascucci received an amendment to the SELIC PPM, which stated,
as in the SELIC PPMs, that it continued to be true that “the Company
[now MetLife] is the legal owner of the assets in all the Separate
Accounts”.

The GenAm Policies

       On February 28, 2001, GenAm (already owned by MetLife) issued
five private placement memoranda (“GenAm PPMs”) that offered
flexible premium variable life insurance policies (referred to as
“Contracts”) to eligible purchasers (referred to as “Contract Holders”). 4

       3 On its cover page the SELIC PPM was entitled “A Private Placement Offering

for Large Case Life I Group Certificate of Insurance with a Limited Partnership
Separate Account / Clients of Tremont / A Group Flexible Premium Life Insurance
Product Offered by the Security Equity Life Insurance Company”.
       4 The parties ostensibly stipulated that MetLife acquired GenAm in 2003, see

Doc. 44, para. 102, but each of the GenAm PPMs states: “On January 6, 2000 The
Metropolitan Life Insurance Company of New York (‘MetLife’) acquired GenAmerican
Corporation. As a result of that transaction, General American became an indirect,
wholly-owned subsidiary of MetLife.”         See, e.g., Ex. 18-P, at 14 (Doc. 46
at PASC_001262).
                                         4

[*4] The Net Cash Value of the Contracts would vary over time with the
investment performance of the Investment Portfolios of the Separate
Accounts into which the Net Premiums were invested. Each of the
GenAm PPMs explains that “[t]he Company [i.e., GenAm] owns the
assets of the Separate Accounts”, 5 but that the separate accounts were
segregated from GenAm’s general account and any other separate
accounts. Further, there was no guarantee by GenAm as to the Net
Cash Value, and each Contract Holder bore the entire investment risk.
Contract Holders were able to allocate the premiums paid to or among
various Investment Portfolios contained in the Separate Accounts.

Madoff/BLMIS

        Bernard Madoff founded Bernard L. Madoff Investment
Securities (“BLMIS”) in 1959 as a sole proprietorship before forming it
as a limited liability company in January 2001. BLMIS claimed to
provide investors a secure investment with a high rate of return using a
“split strike conversion” strategy. Mr. Madoff received billions of dollars
from approximately 4,800 client accounts and, as he eventually
admitted, used the funds to operate the Madoff Ponzi scheme through
BLMIS. As he later explained (in his allocution):

              The essence of my scheme was that I represented to
       clients and prospective clients who wished to open
       investment advisory and individual trading accounts with
       me that I would invest their money in shares of common
       stock, options, and other securities of large well-known
       corporations, and upon request, would return to them their
       profits and principal. Those representations were false for
       many years. Up until I was arrested on December 11, 2008,
       I never invested these funds in the securities, as I had
       promised. Instead, those funds were deposited in a bank
       account at Chase Manhattan Bank. When clients wished
       to receive the profits they believed they had earned with
       me or to redeem their principal, I used the money in the
       Chase Manhattan bank account that belonged to them or
       other clients to pay the requested funds.

       5 Appendix C to the GenAm PPMs reaffirms that “the assets of the Separate

Accounts are the property of General American”. See, e.g., Ex. 18-P, at C-1 (Doc. 46
at PASC_001297).
                                       5

[*5] On December 11, 2008, Mr. Madoff was arrested for—and
ultimately pleaded guilty to—securities fraud, investment adviser
fraud, mail fraud, wire fraud, money laundering, false statements,
perjury, false filings with the Securities and Exchange Commission, and
theft from an employee benefit plan. On June 29, 2009, he was
sentenced to 150 years in prison. It was later determined that the
number of identifiable victims of Mr. Madoff’s crimes made restitution
impracticable and that attempts to determine complex issues relating to
the causes or amounts of losses would complicate or prolong the
sentencing process. Therefore, the U.S. District Court for the Southern
District of New York authorized the Federal Government to proceed
under forfeiture statutes. See 21 U.S.C. § 853(i). Mr. Madoff died in
prison in 2021.

The Tremont Opportunity Fund

      The investment of Mr. Pascucci’s life insurance premiums into the
Madoff Ponzi scheme began in 2001 with an entity eventually called the
Tremont Opportunity Fund III, LP (“Tremont”). 6 (As we set out in
greater detail below, Mr. Pascucci paid premiums into the insurance
companies’ separate accounts, which invested them in Tremont, which
invested a portion of them in an entity called Rye Broad Market Series
(“Rye Broad”), which invested that portion in BLMIS, from which
Mr. Madoff committed his theft.)

       In January 2001 Tremont offered to insurance companies via a
Confidential Private Placement Memorandum the opportunity to invest
in it by acquiring limited partnership interests. Insurance companies
could acquire partnership interests in Tremont with the funds in
separate accounts of individuals who held variable life insurance and
variable annuity contracts. Individuals could allocate their premiums
to the separate account which invested in Tremont. The insurance
company would then have a limited partnership interest in Tremont and
would have no right to manage or control the partnership and would not
have any right to manage or control investment decisions or selection of

       6 In 2001 Tremont was called “the American Masters Opportunity Insurance

Fund, L.P.” (“AMOIF”), which had been organized as a Delaware limited partnership
on December 18, 2000; and Tremont Partners, Inc. (“Tremont Partners”), was the
general partner of AMOIF. Tremont Partners was a wholly owned subsidiary of
Tremont Advisors, Inc. AMOIF was renamed “the Tremont Opportunity Insurance
Fund, L.P.” and was subsequently renamed “the Tremont Opportunity Fund III, L.P.”
                                           6

[*6] fund managers. Tremont’s general partner had sole discretion in
choosing Tremont’s investment managers.

       GenAm and SELIC determined to offer to their policy holders an
option of investing in Tremont. Appendices to the GenAm PPMs issued
in February 2001 stated that an investor could allocate premiums to
“Separate Account Forty-Nine”, by which the funds would be invested in
Tremont. See, e.g., Ex. 18-P, at C-2. Similarly, MetLife’s December 2003
amendment (Ex. 17-P) to the SELIC PPM authorized an investor to
allocate premiums to “Separate Account Seventy-Four”, by which the
funds would be invested in Tremont.

       Mr. Pascucci opted to allocate his premiums to the separate
accounts with which GenAm and SELIC invested in Tremont.
Petitioners acknowledge that they did not choose and could not replace
Tremont’s investment managers, that they did not have and did not
exercise any control over Tremont’s investments, and that they did not
and could not compel Tremont to make any particular investment.

Tremont to Rye Broad to BLMIS

      Mr. Pascucci’s investment of life insurance premiums into
Madoff’s BLMIS was made indirectly: He invested directly into GenAm’s
Separate Account 49 and SELIC’s Separate Account 74. GenAm and
SELIC invested in Tremont. As of November 2008, Tremont had
approximately 21.64% of its assets invested in Rye Broad, 7 which were
“feeder funds” that invested nearly all of their funds with BLMIS. It was
from BLMIS that Mr. Madoff committed theft.

      After the collapse of the Madoff Ponzi scheme, Rye Broad
informed its clients that their investments with it were worthless.
Consequently, the value of Tremont’s assets decreased by approximately
21.64%, and the values of the GenAm and SELIC separate funds were
concomitantly reduced. That is, Mr. Madoff’s theft from BLMIS
rendered Rye Broad worthless, reducing the values of the separate
accounts and thus making Mr. Pascucci’s life insurance policies worth
much less. The Commissioner admits: “[T]he cash values of the Policies

       7 The parties’ stipulation states that in January 2009 Tremont Partners (the

general partner of AMOIF/Tremont, see supra note 6) was “General Partner for the
[Rye] Funds”. As far as we know, the record in this case does not provide further detail
about the relationship of Tremont to Rye Broad nor about when Tremont Partners
became “General Partner for the [Rye] Funds”.
                                     7

[*7] did decline as a result of the collapse of Madoff’s Ponzi scheme and
the theft of Rye Broad Market Series’ assets.”

       However, even after the Madoff Ponzi scheme unraveled,
Mr. Pascucci still owned the insurance policies; GenAm and SELIC still
owned (and held in the separate accounts) the limited partnership
interests in Tremont; Tremont still owned the shares in Rye Broad; and
Rye Broad still owned its shares in BLMIS—though the BLMIS shares
and the Rye Broad shares were worthless.

Direct investment through CSP

       No longer in dispute in this case are other Madoff losses that the
Pascuccis suffered.     Their family partnership, CSP Investment
Associates LLC (“CSP”), had directly invested $9.1 million in BLMIS
and lost that entire amount. (The IRS does not dispute the Pascuccis’
tax treatment of that loss, as described below.)

The Madoff Victim Fund

       Sadly, Mr. Pascucci was one of a large group of victims.
The Madoff Victim Fund (“MVF”) was established by the Department of
Justice (“DOJ”) to distribute more than $4 billion in assets forfeited from
BLMIS and related persons to individuals who invested in, and suffered
a loss resulting from the collapse of, BLMIS. Eligibility requirements
for relief through the MVF were relatively simple: If an individual had
his own money invested in BLMIS and suffered an actual loss when the
fraud was exposed, then he could seek recovery. The MVF program was
“unique” in that it focused not on the feeder funds invested in BLMIS
but on the “ultimate investor”. Mr. Pascucci applied for relief through
the MVF in February 2014 and was approved for an eligible loss amount
of $202,766 on February 27, 2018.

The Pascuccis’ Forms 1040 and 1045

        The Pascuccis timely filed their Form 1040, “U.S. Individual
Income Tax Return”, in October 2009. On that return they claimed
Madoff-related losses totaling $17.3 million, consisting of $9.1 million of
other miscellaneous deductions for the CSP losses and $8.2 million of
theft losses derived from the variable life insurance policies. As a result,
they reported for 2008 a net operating loss (“NOL”) and zero income tax
liability and claimed an overpayment.
                                            8

[*8] To carry that NOL back to tax years 2005, 2006, and 2007, the
Pascuccis filed on December 16, 2009, Form 1045, “Application for
Tentative Refund”, asserting an NOL of $17.5 million 8 in 2008 and
claiming NOL carrybacks of $6.3 million for 2005, $9.2 million for 2006,
and $2 million for 2007. Apparently the IRS allowed refunds for some
or all of the years at issue.

Notice of Deficiency

       On December 11, 2018, the Commissioner sent to the Pascuccis a
Notice of Deficiency (“NOD”) determining tax deficiencies of $1.7 million
for 2005, $1.73 million for 2006, and about $320,000 for 2008. The NOD
explained on Form 886–A, “Explanation of Adjustments”, that the NOL
deduction from the 2008 tax year was disallowed and that therefore the
resulting NOL carrybacks for tax years 2005 and 2006 were also
disallowed. Aside from miscellaneous deductions now conceded by the
Commissioner, the NOD disallowed the Pascuccis’ claimed casualty and
theft loss deduction because they failed to establish that a casualty or
theft occurred and that they sustained such a loss.

Tax Court proceedings

       After concessions, 9 the only issue remaining before the Court is
whether the Pascuccis are entitled to a theft loss deduction for the 2008
tax year (and to the related carrybacks). The parties agreed that no trial
is necessary and that all the relevant facts could be stipulated under
Rule 122.

        8 We do not attempt to resolve the discrepancy between the $17.3 million on

Form 1040 and the $17.5 million on Form 1045. The parties can address the matter,
if necessary, under Rule 155.
        9 The parties filed a Stipulation of Settled Issues on April 1, 2022, in which the

Commissioner conceded the $9.1 million adjustment to Other Miscellaneous
Deductions (for Madoff-related losses incurred by the Pascuccis’ family partnership,
discussed below), leaving only the issue of the theft loss deduction. The Commissioner
further conceded that, if the Court determines that the Pascuccis are entitled to a
casualty and theft loss deduction, they have met their burden of showing there was no
reasonable prospect of recovery at the close of the 2008 tax year.
                                           9

[*9]                                 Discussion

I.      General legal principles

        A.      Burden of proof

       A taxpayer generally bears the burden of proof when contesting
the determinations in an NOD. See Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933). That is, the burden to prove an entitlement to a
deduction falls on the taxpayer. INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 85 (1992). As we noted above, this case was submitted fully
stipulated under Rule 122, but “[t]he fact of submission of a case, under
paragraph (a) of this Rule, does not alter the burden of proof, or the
requirements otherwise applicable with respect to adducing proof, or the
effect of failure of proof.” Rule 122(b). The Pascuccis do not argue that
the burden of proof has shifted pursuant to section 7491(a).

        B.      Tax treatment of life insurance and annuities

        The Policies in this case are a form of private-placement variable
life insurance. Private-placement insurance is sold exclusively through
a private-placement offering. These policies are marketed chiefly to
high-net-worth individuals who qualify as accredited investors under
the Securities Act of 1933. See 15 U.S.C. § 77b(a)(15) (2006); 17 C.F.R.
§ 230.501(a) (2006).

       Variable life insurance is a form of cash value insurance. Under
traditional cash value insurance, the policyholder typically pays a level
premium during life and the beneficiary receives a fixed death benefit.
Under a variable policy, both the premiums and the death benefit may
fluctuate. The assets held for the benefit of the policy are placed in a
“segregated asset account”, that is, an account “segregated from the
general asset accounts of the [insurance] company”. § 817(d)(1). 10 The
policy earns not a fixed or predictable rate of return but instead a return
dictated by the actual performance of the investments in this separate
account.

      If the assets in the separate account perform well, the premiums
required to keep the policy in force may be reduced as the account

       10 Segregated accounts must be adequately diversified as required by Treasury

Regulation § 1.817-5(b)(1). The Commissioner does not contend that the separate
accounts at issue here failed the section 817(h) asset diversification requirements, and
so we do not discuss them further.
                                    10

[*10] buildup lessens the insurer’s mortality risk. If those assets
perform extremely well, as seemed to be the case with Mr. Pascucci’s
Policies before the Madoff Ponzi scheme unraveled, the value of the
policy may substantially exceed the minimum death benefit. If that
occurs, then upon the insured’s death, the beneficiary receives the
greater of the minimum death benefit or the value of the separate
account. If instead the separate account performs poorly and the value
of its assets falls, then the amount received by the beneficiary is limited
to the minimum death benefit of the policy.

       Life insurance and annuities enjoy favorable tax treatment.
Under section 72, earnings that accrue to cash value and annuity
policies—often referred to as the “inside buildup”—are not currently
taxable to the policyholder (and in general are not taxable to the
insurance company). The cash value of the policy thus grows more
rapidly than the value of a taxable investment portfolio.            The
policyholder may access this value, often on a tax-free basis, by
withdrawals and policy loans during the insured’s lifetime. See § 72(e).
If the contract is held until the insured’s death, then the insurance
proceeds (the death benefit) generally are excluded from the
beneficiary’s income under section 101(a). With proper structuring, the
death benefit will also be excluded from the estate tax. See § 2042.

      C.     The investor control doctrine

       While ownership of the assets in the separate accounts of a
variable life insurance policy is assumed to belong to the insurance
company, a policyholder will be considered the owner for tax purposes if
his “incidents of ownership over those assets become sufficiently
capacious and comprehensive”. Webber v. Commissioner, 144 T.C. 324,
350 (2015). If, after all facts and circumstances are considered, the
policyholder is determined to be the owner of the assets in the separate
accounts, then the hoped-for tax benefit to be enjoyed by the policyholder
on the inside buildup is lost, and the tax on the gain is not deferred.
Helvering v. Clifford, 309 U.S. 331, 335–36 (1940); Webber, 144 T.C.
at 360–61. This principle is referred to as the “investor control doctrine”,
and it is a particular application of the general, long-held principle that
“tax liability attaches to ownership.” Blair v. Commissioner, 300 U.S. 5,
12 (1937). While the Pascuccis initially affirm in their briefs that
Mr. Pascucci lacked investor control over the assets in the separate
accounts (an affirmation necessary to their avoiding taxation on the
inside buildup), they later make the argument that Mr. Pascucci had
sufficient “burdens and benefits” under the Policies to be considered an
                                   11

[*11] owner of the assets in the separate accounts. However, to make
this argument, they rely on the incidents of ownership whose existence
or absence governs the application of the investor control doctrine. For
that reason, we discuss here how the doctrine has been applied in the
following previous cases.

       In Webber, the owner of life insurance funded by separate
accounts was held to have exercised “sufficiently capacious and
comprehensive” control over the separate accounts of his life insurance
policies because he directed the investment manager to “buy, sell, and
exchange securities and other property”, particularly in companies in
which the taxpayer sat on the board and in which he invested his
personal accounts, individual retirement accounts, and private-equity
funds. Webber, 144 T.C. at 350, 364. Further, there was no evidence
before the Court that the investment manager acted independently by
researching the “suggestions” made by the taxpayer as to investment
strategy and companies. Id. at 362. The taxpayer could, and did, extract
cash “at will” from the separate accounts without resorting to policy
loans. Id. at 366–67. Finally, the Court found that the taxpayer’s ability
to derive other benefits through his separate accounts, highlighting
specifically the way the separate accounts’ investments mirrored his
own personal investments, made the separate accounts “a private
investment account through which he actively managed a portion of his
family’s securities portfolio.” Id. at 367. In coming to its decision, the
Court cited relevant Revenue Rulings in which the IRS described the
“investor control” doctrine and the standards through which the IRS
would evaluate a taxpayer’s control over separate accounts. See id.
at 353–57.

       Similarly, in Corliss v. Bowers, 281 U.S. 376 (1930), the taxpayer
was liable for taxes on funds that were held in trust and were made
payable to his wife, when he reserved the power to modify or revoke the
trust at any time. The Court invoked the investor control doctrine and
reasoned that “[t]he income that is subject to a man’s unfettered
command and that he is free to enjoy at his own opinion may be taxed
to him as his income, whether he sees fit to enjoy it or not.” Id. at 378.

       To inform our interpretation of the Code, this Court may look not
only to regulations and caselaw, but also to relevant Revenue Rulings
with a “power to persuade”. Skidmore v. Swift & Co., 323 U.S. 134, 140
(1944); Webber, 144 T.C. at 353. Consequently, we consider Revenue
Ruling 77-85, 1977-1 C.B. 12, 14, which noted that an “insurance
company must be the owner of the assets in the segregated accounts” in
                                          12

[*12] order for a policy to qualify as a “variable contract” based on a
“segregated asset account” within the meaning of section 817(d). In the
scenario addressed by Revenue Ruling 77-85, 1977-1 C.B. at 14, the
policyholder was held to be the owner of the assets even after depositing
them with a custodian because he controlled all aspects of how the
custodian invested the assets and even had the option to surrender the
policy at any point before the annuity starting date (the date on which
he would receive his first payment under the annuity). Therefore, the
level of control the policyholder exercised was so similar to the level of
control he would have had if the assets had still been in his direct
possession, that he would “effectively enjoy[] the benefit of any income
produced by, and any increase in the value of, the assets in the custodial
account”. 11 Id.

       Revenue Ruling 81-225, 1981-2 C.B. 12, addressed four scenarios
in which mutual fund shares, which were purchased with assets in
separate accounts, were available publicly. In that instance, the
insurance companies were “little more than a conduit between the
policyholders and their mutual fund shares”, and the investor was
considered to have control. Id. at 14. However, if the shares were
available only through the purchase of an annuity contract, then the
investor would lack control and the insurance company would be the
true owner of the assets. Id.

       Not only must shares purchased with assets in a separate account
not be available publicly, in order for the insurance company to be
considered the owner of the shares, but also “control over individual
investment decisions must not be in the hands of the policyholders.”
Rev. Rul. 82-54, 1982-1 C.B. 11, 12. However, without falling afoul of
the investor control doctrine, a policyholder may have the right to
change the allocation of his premiums among subaccounts at any time
and to transfer funds among subaccounts, so long as the policyholder
“cannot select or recommend particular investments”, “cannot
communicate directly or indirectly with any investment
officer . . . regarding the selection . . . of any specific investment or
group of investments”, and so long as “[t]here is no arrangement, plan,
contract, or agreement” between the policyholder and the insurance

        11 That the assets were held in a custodial account did not affect the ownership

of the assets because “[t]he setting aside of the assets in the custodial account for the
purchase of term annuities is basically a pledge arrangement”, and property held in
trust or escrow to satisfy legal obligations for an individual is deemed to be the
property of said individual. Rev. Rul. 77-85, 1977-1 C.B. at 14–15.
                                          13

[*13] company or investment manager regarding “the investment
strategy of any [s]ub-account, or the assets to be held by a particular
sub-account.” Rev. Rul. 2003-91, 2003-2 C.B. 347, 348.

       As we explain below, Mr. Pascucci’s Policies successfully dodged
the hazards, and he was considered not to have investor control. But,
as we will show, that lack of control fatally undermines his contention
that he has an ownership interest sufficient to entitle him to deduct a
theft loss.

       D.      Theft loss deduction

       An individual may generally deduct “any loss sustained during
the taxable year and not compensated for by insurance or otherwise.”
§ 165(a). A loss of property neither connected with a trade or business
nor entered into for profit, as is the case here, 12 qualifies for a deduction
only if it arises from “fire, storm, shipwreck, or other casualty, or from
theft.” § 165(a), (c)(3).

               1.      Prerequisites for a theft loss deduction

       An individual claiming a theft loss deduction must show (1) that
a theft occurred, (2) that there was no reasonable chance of recovery of
the property, and (3) that he owned the property at the time it was
stolen. See Grothues v. Commissioner, T.C. Memo. 2002-287. In dispute
here is only the third prerequisite—i.e., whether the Pascuccis owned
the assets in the separate accounts at the time of the theft by
Mr. Madoff—but we discuss briefly the first two before addressing that
dispute.

                       a.      Occurrence of a theft

      Theft for the purposes of section 165(c)(3) includes, but is not
limited to, larceny, embezzlement, and robbery. Treas. Reg. § 1.165-
8(d). The act resulting in the alleged theft loss must have been a
criminal act under the law of the state in which the alleged theft
occurred. Paine v. Commissioner, 63 T.C. 736, 740 (1975), aff’d, 523 F.2d

         12 The property for which the Pascuccis claim the theft loss deduction is the

assets contained in the separate accounts of both MetLife and GenAm. However, as is
discussed below, the actual property which the Pascuccis own are the policies and
certificates with MetLife and GenAm, the value of which declined after the collapse of
the Madoff Ponzi scheme. The parties apparently agree that neither policy was
connected with a trade or business and that neither policy was entered into for profit.
                                   14

[*14] 1053 (5th Cir. 1975) (unpublished table decision); Montelone v.
Commissioner, 34 T.C. 688, 694 (1960); Allen v. Commissioner, 16 T.C.
163, 166 (1951).

       To be entitled to a theft loss deduction, the Pascuccis must
establish that a theft occurred under New York law, because that is
where Mr. Madoff’s acts occurred. New York Penal Code § 155.05 (West
2023) provides that “[a] person steals property and commits larceny
when, with intent to deprive another of property or to appropriate the
same to himself or to a third person, he wrongfully takes, obtains or
withholds such property from an owner thereof.”

       This definition of larceny includes embezzlement, obtaining
property by false pretenses, acquiring lost property, and false promise.
Id. The parties agree that a theft was committed (i.e., by Mr. Madoff),
but they disagree about whether that theft was from the Pascuccis. See
infra Part II.C.3.

                    b.    Prospect of recovery

       The regulations promulgated under section 165 provide, as to
theft losses: “[I]f in the year of discovery there exists a claim for
reimbursement with respect to which there is a reasonable prospect of
recovery, see paragraph (d) of § 1.165-1.” Treas. Reg. § 1.165-8(a)(2).
The cross-referenced paragraph (d) provides rules about, inter alia, the
year for which the deduction will be allowed when there is a prospect of
recovery. The Commissioner does not contend that, by the end of 2008,
there was a further prospect of recovery, so it is agreed that, if a theft
loss deduction is permitted here, then 2008 is the correct year.

                    c.    Ownership of the property

       The theft loss deduction is available only to the person who was
the owner of the stolen property at the time it was criminally
appropriated. Lupton v. Commissioner, 19 B.T.A. 166 (1930); Grothues,
T.C. Memo. 2002-287; Malik v. Commissioner, T.C. Memo. 1995-204
(holding that the taxpayer who gave funds to a club’s partners could not
claim a theft loss deduction for funds embezzled from a club because the
club (not the taxpayer) had possession and control, and therefore
ownership, of the funds at the time they were embezzled).

      As we discussed above in Part I.D.1.a., theft under New York law
occurs when a person “wrongfully takes, obtains or withholds . . .
property from an owner thereof.” (Emphasis added.) The “owner” of
                                     15

[*15] property under section 155.00 of the New York Penal Code is “any
person who has a right to possession thereof superior to that of the taker,
obtainer or withholder.” In instances of joint or common ownership, and
“[i]n the absence of a specific agreement to the contrary, a person in
lawful possession shall be deemed to have a right of possession superior
to that of a person having only a security interest therein”. Id.

              2.     Safe harbor of Revenue Procedure 2009-20

       In response to the revelation of the Madoff Ponzi scheme, the IRS
issued Revenue Procedure 2009-20, 2009-14 I.R.B. 749, to provide, for
those claiming the deduction, a safe harbor that provides some clarity
as to how the agency would apply the foregoing prerequisites. Under
the IRS’s guidance, a “qualified investor” is eligible to claim the
deduction under the safe harbor. Rev. Proc. 2009-20, § 4.03, 2009-14
I.R.B. at 750, specifies that a qualified investor “does not include a
person that invested solely in a fund or other entity (separate from the
investor for federal income tax purposes) that invested in the specified
fraudulent arrangement.” Where such an investment had been made,
only “the fund or entity itself may be a qualified investor within the
scope of this revenue procedure.” Id. The failure to meet the
requirements of the safe harbor is not determinative of one’s ability to
claim a theft loss resulting from a Ponzi scheme. Rather, qualifying
under the safe harbor assured taxpayers that their deduction would not
be challenged by the IRS.

       The Commissioner does not dispute that a theft occurred, and he
concedes that there was no reasonable chance of recovery, leaving at
issue only the question whether Mr. Pascucci owned the property at the
time of the theft.

II.    Analysis

       The Pascuccis must demonstrate that they suffered a loss as a
result of a theft in order to succeed in their claim of a theft loss deduction
for the 2008 tax year (and of NOL carrybacks to previous years). For
the reasons we now explain, we hold that Mr. Pascucci did not own the
assets in the separate accounts at the time of the Madoff theft, and
therefore the Pascuccis are not entitled to a theft loss deduction.
                                   16

[*16] A.     Eligibility through the Revenue Procedure 2009-20 safe
             harbor

        For CSP’s direct investment in BLMIS, the Pascuccis qualify for
the safe harbor of Revenue Procedure 2009-20 because they were
qualified investors, and the Commissioner so concedes. However, the
Pascuccis do not qualify for the safe harbor as to their investments in
the variable life insurance policies, because in that context they were
not qualified investors. They do not contend otherwise. As to the life
insurance policies, Mr. Pascucci did not invest in a “fund or other entity
. . . that invested in the specified fraudulent arrangement”; instead, he
was further removed from the fraud. Each fund in which they invested
(i.e., the separate accounts owned by GenAm and SELIC) had itself
invested some of its money in “a fund or other entity” (Tremont) that in
turn had invested 21.64% of its money in a fund (Rye Broad) that had
invested all of its money in the “fraudulent arrangement”—BLMIS—
from which the theft actually occurred. That is, the money in the
separate accounts was not directly deposited with BLMIS and was not
made subject to the Madoff Ponzi scheme. It was Rye Broad, not
Mr. Pascucci, that deposited assets with BLMIS for an investment that
never occurred. (The safe harbor would be unavailable even if we found
that Mr. Pascucci himself was the owner of the assets in the separate
accounts, since the investment from those accounts—indirectly through
Tremont and then through Rye Broad—was still too far removed from
the “fraudulent arrangement” of BLMIS.)

       The safe harbor analysis, however, does not end this matter, since
eligibility for the safe harbor is only one means to show entitlement to a
theft loss deduction. The Pascuccis contend that they make that
showing apart from the safe harbor.

      B.     Ownership of the assets in the separate accounts

       Under the express policy terms of both SELIC and GenAm, those
companies owned the assets of the separate accounts during the 2008
tax year. The Pascuccis do not dispute this proposition, nor the
Commissioner’s showing that, under state law, the separate account
assets are owned by the insurance companies.

       The Pascuccis further admit that “for income tax purposes the
insurance company owns the assets reflected in the separate account”,
and they admit that Mr. Pascucci is “deemed under the investor control
doctrine to not own the separate accounts directly”. (These admissions
                                       17

[*17] benefit them as to favorable tax treatment of inside buildup.)
However, they argue that even though Mr. Pascucci did not own the
assets in the separate accounts under the terms of the accounts, under
state law, or under the “investor control” doctrine, he nonetheless had
“a property interest therein” and possessed sufficient “incidents of
ownership” and “tax and economic benefits and burdens of appreciation
and depreciation of the assets” to be considered the owner of the assets
in the separate accounts for purposes of a theft loss deduction. We
disagree.

       Mr. Pascucci did not have investor control over the assets in the
separate accounts. He had no control over the investment strategy of
the assets once allocated; he had only typical policyholder rights under
his policies and contracts; and the Pascuccis offer no evidence that they
derived other benefits from any control over the assets in the separate
accounts. 13

       It was Tremont’s general partner who designated the investment
managers for the funds in Tremont. Mr. Pascucci had no right and made
no attempt to influence the selection of investment managers nor the
making of investments by Tremont. That is to say, Mr. Pascucci’s only
role was to select the separate funds in which to put his premiums, and
he had no control thereafter over the assets in the separate accounts.
Whereas the investment manager in Webber, 144 T.C. at 361, acted only
at the direction of the policyholder without any attempt to
independently assess investment strategies, there is no evidence before
us to suggest that Mr. Pascucci even contacted the investment managers
for Tremont, let alone directed the investment managers’ actions.
According to Revenue Ruling 2003-91, these facts would indicate that
the insurance company, rather than Mr. Pascucci, was the owner of the
assets in the separate accounts—not only the owner of legal title (which
it certainly was) but also the owner for tax purposes.

       Mr. Pascucci’s voting rights under the Policies were typical rights
contemplated by state law and do not qualify as an incident of ownership
of the assets underlying the Policies. MetLife allowed for voting rights
to pass through to certificate holders, but MetLife still owned the shares
and reserved the right to cease that practice at any time. New York

        13 Examples of these “other benefits” might include “investments that may

have been a source of personal pleasure” and investments that mirror those of the
policyholder’s own private-equity fund or personal portfolio. See Webber, 144 T.C.
at 367. The Pascuccis do not assert that Mr. Pascucci enjoyed such benefits.
                                    18

[*18] state insurance law permits this practice while maintaining that
all assets in separate accounts nonetheless belong to the insurance
company. See N.Y. Ins. Law § 4240(a)(12), (f) (West 2023). Likewise,
Missouri insurance law permits insurance companies to allow special
voting rights for individuals who have policies with separate accounts.
Mo. Rev. Stat. § 376.309(3) (West 2023). The predictable, commonplace
voting rights which Mr. Pascucci possessed are starkly different from
the level of control over voting that the taxpayer exercised in Webber,
144 T.C. at 364–65. The insurance investment managers in Webber
“took no action without a sign-off from [the taxpayer].” Id. Mr. Pascucci
has provided no evidence that his level of control over voting habits of
MetLife consisted of anything beyond the votes of his few shares.

       Finally, Mr. Pascucci’s limited—and never-exercised—ability to
withdraw cash via loans from the policies does not reflect ownership over
the assets in the separate accounts.            As highlighted by the
Commissioner, withdrawal could be made by requesting loans, but the
amount available would be limited to the Insurance Account Value less
certain adjustments, and then interest would be charged on the amount
lent. Moreover, the certificate or contract would have to be assigned to
the insurance company “as sole security for the loan.” This restricted
ability to withdraw does not resemble the kind of “unfettered command”
over assets that is associated with investor control. Corliss v. Bowers,
281 U.S. at 378. Therefore, we find that, as to the assets in the separate
accounts, Mr. Pascucci did not have significant “incidents of ownership”
nor bear significant “benefits or burdens” and, consequently, that he did
not own the assets in the separate accounts for theft loss purposes.

      C.     The Pascuccis’ counterarguments

             1.     Whether the Policies’ diminution in value can
                    support a theft loss deduction

       As we have held, Mr. Pascucci did not own the assets in the
separate accounts maintained by GenAm and SELIC; instead, he owned
the Policies those companies had issued to him. However, the Pascuccis
argue that they are entitled to a theft loss deduction because the Policies
suffered a diminution in value as a result of Mr. Madoff’s theft from
BLMIS. The Policies did indeed suffer a diminution of value as a result
of the Madoff Ponzi scheme—with the result that the DOJ classified
Mr. Pascucci as a “victim” for purposes of receiving compensation from
the MVF—and the question we now face is whether such a diminution
of value can support a theft loss deduction.
                                            19

[*19] Section 165(a) allows a deduction for “any loss”, and subsection (e)
specifies a “loss arising from theft”. (Emphasis added.) One could argue
that a loss may “aris[e] from theft” even if the specific property that was
actually the subject of a theft (here, funds in BLMIS) is distinct from the
property whose value diminished, if that theft causes a “loss” of part of
the value of the distinct property (here, the Policies). For example, an
heir may very understandably feel he has suffered such a “loss” when
his parent is the victim of a theft. The heir anticipated inheriting the
property, but now the heir has suffered a loss, so to speak, of what he
expected to inherit, which loss one could say “arose from” the theft.
Or, as another example, a creditor may similarly feel that he has
suffered a “loss” when his debtor is the victim of a theft. The creditor
expected the debtor to pay him from that property; but now the creditor
will not be repaid and has suffered a loss, so to speak, that one could say
“arose from” the theft. 14 Or a shareholder of a corporation may feel that
he has suffered “loss” when the corporation is the victim of a theft that
causes the market value of the stock to decrease. The shareholder could
say that the decrease in his shareholder value “arose from” the theft
suffered by the corporation. 15

         14 In Silverman v. Commissioner, T.C. Memo. 1975-255, 34 T.C.M. (CCH) 1094,

aff’d, 538 F.2d 320 (3d Cir. 1976) (unpublished table decision), a thief induced a loan
to his MCC corporation by FSS corporation, whose owners advanced the money to FSS.
The thief took the funds from MCC; FSS’s loan to MCC was not repaid; and the owners’
advance to FSS was not repaid. The Tax Court held:
                A theft loss deduction may be claimed only by the taxpayer who
        was the owner of the stolen property when it was criminally
        appropriated. . . .
                . . . FSS must be deemed to have sustained the theft loss for
        purposes of section 165. . . .
                ....
                . . . [P]etitioners intended to maintain FSS as an entity distinct
        from themselves. And they caused it to be sufficiently active that its
        existence should be recognized for purposes of the tax law. . . .
        Therefore we will not disregard the existence of FSS . . . .
Id. at 1096.
        15 Petitioners bring up this scenario and aptly state:

        [A] theft loss is not allowable because the loss did not arise from a theft.
        See, e.g., Marr v. Commissioner, T.C. Memo. 1995-250, 1995 Tax Ct.
        Memo LEXIS 252, at *9–11 (taxpayers not entitled to a theft loss
        deduction where they purchased stock on the open market because
        under state law a relationship between the defrauder and the victim
        was required for the activity to be a theft); Crowell v. Commissioner,
        T.C. Memo. 1986-314, 1986 Tax Ct. Memo LEXIS 288, at *8–10 (same).
                                          20

[*20] However, the theft loss jurisprudence has not taken this
interpretive path. Rather, the Court has confined the theft loss to the
actual owner of the stolen property. See infra Part I.D.1.c. We assume
it is true, as the Pascuccis contend, that, for some purposes, “property”
can include rights under a contract; and we assume arguendo that the
Policies could constitute “property” that, if stolen, would support a theft
loss deduction. However, the Policies were not stolen. Rather, the
property stolen was the money in BLMIS, while the property that was
owned by Mr. Pascucci and that diminished in value was distinct
property—the Policies.

       The contract rights afforded to Mr. Pascucci under the Policies
were the same before and after the collapse of the Madoff Ponzi scheme:
Both before and after, Mr. Pascucci had variable life insurance policies
which, upon death, would yield payment to the beneficiaries named in
the policies. Further, there never was any guaranteed value for any of
the Policies—rather, it was always true that, by their nature, the
Policies might decline in value—and, therefore, the decline in value does
not substantiate a theft from Mr. Pascucci.

                2.      Whether Mr. Pascucci had a property interest in the
                        separate accounts

       In the alternative, the Pascuccis claim that Mr. Pascucci did have
an ownership interest in the stolen property. They cite Alphonso v.
Commissioner, 708 F.3d 344 (2d Cir. 2013), vacating and remanding
136 T.C. 247 (2011), a case involving a casualty loss (not a theft loss) in
which a tenant-stockholder of a cooperative housing corporation
(“housing co-op”) was found to have a property interest in a wall within
the common area of the community and was therefore entitled to a
casualty loss deduction for damage to the wall. That is (the Pascuccis
contend), even though what the taxpayer owned was his share in the
housing co-op, he also was held to have an ownership interest in the wall
owned by the housing co-op, 16 an ownership interest that would support
a theft loss deduction. We are unconvinced, however, that Mr. Pascucci’s
rights under the policies and contracts materially resemble the rights
afforded to a tenant and stockholder (i.e., co-owner) over real property.

        16 The court found that the interest created in a cooperative agreement is sui

generis because “[t]he interest in a cooperative apartment ‘is represented by shares of
stock, which are personal property, yet in reality what is owned is not an interest in an
ongoing business enterprise, but instead a right to possess real property.’” Alphonso v.
Commissioner, 708 F.3d at 352 (quoting In re Estate of Carmer, 525 N.E.2d 734, 734
(N.Y. 1988)).
                                   21

[*21] The tenant in Alphonso had not only an ownership right in the
housing co-op but also the right to enjoy common areas of the property,
of which the wall was a part; and the tenant therefore suffered some loss
of property when the wall was damaged. By contrast, Mr. Pascucci
enjoyed no such rights to own, possess, or use the property that Mr.
Madoff actually stole: the BLMIS funds. Instead, he had only limited
rights to borrow against the assets in the separate accounts held by
MetLife.

       Moreover, as respondent noted, the analysis in Alphonso relied
heavily on state law to determine what rights were generated pursuant
to a lease by a tenant-shareholder of a cooperative apartment. While
New York state property law at issue in Alphonso provided that a
tenant-shareholder of a cooperative agreement holds a real property
interest (i.e., an ownership interest) through a lease, id. at 353, the
insurance law applicable here both in New York (the state whose law
governs the SELIC policies) and in Missouri (the state whose law
governs the GenAm policies) does not create an ownership interest in
the assets of a separate account. Instead, New York insurance law
mandates that assets “allocated by the insurer to separate accounts
shall be owned by the insurer, [and] the assets therein shall be the
property of the insurer”, N.Y. Ins. Law § 4240(a)(12) (emphasis added),
and Missouri insurance law, Mo. Rev. Stat. § 376.309(1) and (2), creates
no further property rights in the assets held in the separate account.

       The Commissioner points to a more apt case to address the
Pascuccis’ property interest argument: In re Bernard L. Madoff
Investment Securities, LLC, 708 F.3d 422 (2d Cir. 2013). That case, also
decided by the Court of Appeals for the Second Circuit, addressed the
question of whether the appellants (individuals who owned limited
partnership interests in a company that had invested in Rye Broad)
were customers of BLMIS for purposes of bankruptcy proceedings. The
court found that the appellants “had no property interest in the assets
that the Feeder Funds [such as Rye Broad] invested with BLMIS”. Id.
at 427–28 (emphasis added). Mr. Pascucci’s connection to BLMIS is
even more attenuated, because he did not even have limited partnership
interests in Rye Broad; in this case the interests in Rye Broad were
owned by Tremont, the interests in Tremont were owned by the separate
accounts, and the separate accounts were owned by GenAm and SELIC.
Mr. Pascucci had no interests in Rye Broad (or BLMIS) but rather owned
policies and contracts whose cash values reflected the values of separate
accounts held by the insurance companies. It was those separate
accounts, owned by the insurance companies in title and control, that
                                           22

[*22] purchased limited partnership interests in a partnership
(Tremont) that then invested with Rye Broad and, thereby indirectly,
with BLMIS.

                3.      Whether there needs only to be a nexus between the
                        reduction in value of the separate accounts and the
                        Madoff Ponzi scheme

       The Pascuccis urge this Court to apply the “sufficient nexus”
standard set forth in Estate of Heller v. Commissioner, 147 T.C. 370
(2016), i.e., to hold that Mr. Pascucci had a “sufficient nexus” to the
assets in the separate accounts to claim a theft loss deduction, but that
standard does not apply here. In Estate of Heller, the Court addressed
an issue of first impression: whether an estate could claim a deduction
under section 2054 (the estate tax version of the theft loss deduction) for
the loss in value of an interest that the estate held in an LLC whose sole
asset was an account with BLMIS that became worthless following the
collapse of the Madoff Ponzi scheme. Section 165(c)(3) (the statute
applicable here) allows a deduction for “losses of property” (emphasis
added), while the text of section 2054 allows a deduction for “losses
incurred”. The text of section 2054, as the Court explained in Estate of
Heller, 147 T.C. at 373, is broad, and that text warranted a broad
interpretation. Section 165(c)(3), on the other hand, allowing a
deduction only for “losses of property”, provides a narrower scope of loss
that warrants an income tax deduction. Further, our jurisprudence
regarding section 165(c)(3) is, unlike that of section 2054 before Estate
of Heller, clear and well settled.

                4.      Whether Tremont and Rye Broad were “merely”
                        middlemen

      Relying on our opinion in Jensen v. Commissioner, T.C. Memo.
1993-393, 1993 WL 325102, aff’d, 72 F.3d 135 (9th Cir. 1995)
(unpublished table decision), the Pascuccis claim that Tremont and Rye
Broad were merely middlemen 17 through which they invested in BLMIS.

        17 In their reply brief, the Pascuccis seem to contend not that Tremont and Rye

Broad were middlemen acting for Mr. Pascucci (like the broker acting for the taxpayer
in Jensen) but instead that they were middlemen acting for Mr. Madoff, serving as
“conduits for Madoff and his Ponzi scheme”. These allegations do not resonate with
Jensen, and this contention fails for lack of evidence. To support it they are able to cite
only hearsay accusations in pleadings filed against Tremont and Rye Broad, but the
reply brief indicates that the cited litigation concluded without any admission or
                                         23

[*23] In Jensen, the taxpayers invested in a Ponzi scheme through a
broker and subsequently claimed a theft loss deduction once the Ponzi
scheme collapsed. Id. We held that, in that instance, the taxpayers’
broker was a middleman, and the taxpayers were therefore entitled to a
theft loss deduction, because the broker had acted on behalf of the
taxpayers in making the investments. In Jensen, “[a]ll of the parties
involved . . . understood that the funds that [the broker] provided to [the
Ponzi scheme] were not merely [the broker’s] funds but were also [the
investing taxpayers’] funds.” Id. at *5. It would have been possible for
the taxpayers in Jensen to invest in the Ponzi scheme directly without
the broker, and the interposing of the middleman made no difference.

       This case is quite different from Jensen. In Jensen the invested
funds were held to be the taxpayer’s funds, only nominally held by his
broker, whereas here both the state statutes and the GenAm and SELIC
documents repeatedly and explicitly provide that not the Pascuccis but
the insurance companies own those assets. Moreover, the investment
by MetLife in Tremont was in exchange for limited partnership interests
that were available not to individual investors (such as Mr. Pascucci)
but only to insurance company investors, as provided in the PPM given
to MetLife by Tremont. 18 Unlike the investors in Jensen, the Pascuccis
themselves could not have invested in Tremont on their own, without
GenAm and SELIC. In this case it was certainly not true that
(interpolating these facts into the discussion in Jensen) “[a]ll of the
parties involved . . . understood that the funds that [the insurance
companies] provided to [Tremont] were not merely [the insurance
companies’] funds but were also [the Pascuccis’] funds.” On the
contrary, Tremont would have understood that the funds that the
insurance companies provided to Tremont were the funds of the
companies’ separate accounts, which are assets owned by the insurance
company and not by its policyholders. Much less would Rye Broad have

adjudication of liability for wrong doing. In the end the contention devolves into the
colloquialism that Tremont and Rye Broad “most certainly were conduits for money
that Madoff stole”. Money was not simply passed from Mr. Pascucci through entities
to Mr. Madoff. Rather, Mr. Pascucci’s money bought him Policies from the insurance
companies; the insurance companies’ money bought shares in Tremont; Tremont’s
money bought shares in Rye Broad; Rye Broad’s money bought shares in BLMIS; and
BLMIS’s money went to a bank account that Mr. Madoff used. We can indeed trace
the money, and we can blame Mr. Madoff for the diminution of value in Mr. Pascucci’s
Policies; but we cannot collapse or ignore the distinct transactions.
        18 The description of the Tremont separate account in the PPMs from SELIC

and GenAm to the Pascuccis also specified that the partnership interests were
available only to insurance companies.
                                         24

[*24] “understood” that the funds it received from Tremont were
Mr. Pascucci’s. The Commissioner argues that the multiple layers of
investment (Mr. Pascucci into the separate accounts, the separate
accounts into Tremont, Tremont into Rye Broad, 19 and Rye Broad into
BLMIS) sufficiently separate Mr. Pascucci from ownership of the BLMIS
funds that Mr. Madoff stole, and we are inclined to agree. Consequently,
we disagree that Tremont and Rye Broad were “merely” middlemen that
we should ignore in determining ownership.

               5.      Whether investor control is irrelevant if the property
                       is stolen

        The Pascuccis’ contention that the investor control doctrine does
not apply to theft loss analysis is unavailing. The investor control
doctrine was developed as a means to discern whether or not income
accruing on assets held in separate accounts as part of a life insurance
or variable annuity contract is taxable to the issuing insurance company
or to the policyholder. As we explained above, tax liability attaches to
the ownership of income. Consequently, the investor control doctrine,
as it informs the determination whether income on assets is taxable to
a policyholder is, in actuality, informing the determination whether that
policyholder truly owns the assets in the separate accounts. Only the
owner of an income-producing asset should owe tax on that income.

       Similarly, entitlement to a theft loss deduction attaches to the
ownership of the property. Only the owner of an asset may claim a theft
loss deduction when it is stolen. It naturally follows that the application
of the investor control doctrine is appropriate for informing the decision
whether the policyholder owns the assets in the investment account.

       In the alternative, the Pascuccis urge the Court to disregard the
“investor control” doctrine in determining ownership of the funds, on the
ground that the disputed funds were stolen by Mr. Madoff, not invested
at all. As a result of this theft, the Pascuccis contend, there was no

        19 Tremont’s general partner was, in 2009, also the general partner of the Rye

Broad funds. See supra note 7. One could speculate that in 2001 and 2003 the Rye
Funds might have been controlled by Tremont; that Rye Broad should be viewed as
Tremont’s alter ego; that the transactions between them should therefore be collapsed;
and that the series of transactions should be deemed one transaction shorter. We have
not been pointed to evidence in the record that would support this scenario, and we
decline to speculate. And even if the series were one transaction shorter, there would
still be multiple transactions among distinct parties that would separate
Mr. Pascucci’s investment in the separate accounts from Mr. Madoff’s theft.
                                    25

[*25] investment to have control over, and therefore the investor control
doctrine is irrelevant. This contention is without merit because it asks
the investor control question at the wrong stage—i.e., three transactions
after the pertinent investment. The investor control doctrine, when
invoked in this theft loss context, is helping us to answer the question of
who owned the (later stolen) funds after they were invested in the
insurance company (and before the theft occurred). Did Mr. Pascucci
own the premiums even though he had invested them with an insurance
company? There is no doubt that Mr. Pascucci paid his premiums to the
insurance company as an investment and that the insurance company
received them as an investment. No theft yet complicates the ownership
question, the answer to which is simple: We know that the company—
and not Mr. Pascucci—now owns the funds because the company, not
the investor, controls the funds. When a theft thereafter occurs (three
transactions later), it does not change our investor control analysis nor
our occasion for employing it. We are able to say that no theft occurred
from Mr. Pascucci because he did not own the asset after he made his
investment. The later theft certainly did not cause Mr. Pascucci to
become anything other than an investor.

             6.     Whether the tax deferral of the separate accounts has
                    a bearing on the Pascuccis’ entitlement to a theft loss
                    deduction

       The Commissioner aptly observes that the Pascuccis benefited
from deferral of tax on the separate accounts because they claimed that
they did not own, and are treated as not having owned, the assets within
the separate accounts. The Pascuccis apparently misunderstand this
observation, and they rebut an argument that the Commissioner did not
actually make—i.e., they deny that a prior tax deferral eliminates one’s
claim to a theft loss deduction. Such an argument would indeed have
no merit; but the actual point to which the Commissioner’s observation
is relevant is that before the theft, the Pascuccis benefited from, and did
not challenge, the fact that the assets contained in the separate accounts
at issue were owned by MetLife and GenAm, and therefore, because the
Pascuccis did not own those assets, they were not liable for any tax
related to those assets. The Pascuccis cannot have it both ways: They
cannot simultaneously enjoy the tax deferral benefit of not owning
assets in the separate accounts and also claim a tax deduction that is a
benefit available only to someone who did own the assets.
                                    26

[*26]         7.     Whether the Madoff Victim Fund’s determination
                     that the Pascuccis were crime “victims” satisfies the
                     section 165 requirement that the loss arise from a
                     theft

       The Pascuccis argue that the relief provided to them as “victims”
by the MVF is proof that they owned the assets in the separate accounts,
that they suffered a theft, and that they are therefore entitled to their
claimed theft loss deduction. We disagree. The MVF was created by the
Department of Justice to provide some relief to the thousands of
individuals affected by Mr. Madoff, with the understanding that indirect
investors made up the majority of those thousands. The MVF was
understood to be “unique” (i.e., generous and broad) because of its focus
on the “ultimate investor” rather than on the feeder and mutual funds
that had directly invested in BLMIS and that had actionable claims in
bankruptcy actions. The Pascuccis have not shown that the MVF offered
or announced (or had any authority to offer or announce) any federal tax
rulings or principles. Rather, it determined that the Pascuccis were
eligible to obtain relief from the MVF; but it made no determination as
to whether the Pascuccis met the requirements of section 165 to be
entitled to the theft loss deduction they seek. For the reasons stated
above, they did not meet those requirements.

III.    Conclusion

       The Pascuccis are not entitled to a theft loss deduction under
section 165 for the diminution in value of the assets in the separate
accounts, because they did not own the assets at the time of the theft.

      To reflect the foregoing, and to effect the Commissioner’s
concession of the other miscellaneous deductions,

        Decision will be entered under Rule 155.