Madoff Victims May Have Taxing Alternative To Lawsuits

Jan 22 2009 | 12:22am ET

There may be next to nothing left for the victims of Bernard Madoff’s alleged Ponzi scheme to recover via lawsuits, but the tax man may yet prove their salvation.

The U.S.’s Byzantine tax code provides a variety of potential remedies for victims of fraud and theft. According to Bloomberg News, some Madoff investors could recover as much as 40% of the money lost; not bad, considering that authorities say Bernard L. Madoff Securities had only about $300 million of the $50 billion that may have been lost in the alleged scam.

If investors can prove that their money was stolen—and Madoff has allegedly confessed his crimes—and that they are unlikely to recover it through other channels, they are entitled to claim that theft as a loss for tax purposes. If the loss is greater than a victim’s annual income, which in some Madoff cases it almost certainly will be, the loss can be carried back three years and forward 20 years to reduce taxable income.

The theft-loss provision would also cover those who lost money indirectly, such as investors in Madoff feeder funds.

There is some disagreement as to just how much may be recoverable, and what the restrictions are. Investors who do not first seek to recover their losses through the Securities Investor Protection Corp., they could see have their maximum deduction lowered by $500,000. What’s more, the Internal Revenue Service says that the total loss must be more than 10% of a taxpayer’s adjusted gross income for the year the deduction is claimed.

Nor is it clear how the IRS would handle claims that Madoff stole money that was never actually there. While investors’ principal would be covered, they may only be able to recoup taxes paid on their phony investment gains over the years, rather than getting a deduction for it.


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