The Internal Revenue Service has extended a safe harbor for investors who claim theft loss deductions from fraudulent investment arrangements, such as Ponzi schemes, even when the leading figure behind the fraud has died.

Rev. Proc. 2011-58 modifies an earlier revenue procedure, Rev. Proc. 2009-20, 2009-1 C.B. 749, which provides an optional safe harbor allowing certain investors to claim a theft loss deduction for qualified losses  from specified fraudulent investment arrangements for which authorities have charged the lead figure by indictment, information, or criminal complaint with a crime that meets the definition of theft for purposes of Section 165 of the Tax Code. 

Rev. Proc. 2011-58 addresses certain situations in which the death of a lead figure has foreclosed the possibility of criminal charges. The new rules extends the safe harbor in that event to certain cases in which a lead figure or associated entity is the subject of a state or federal government civil complaint alleging the elements of a specified fraudulent arrangement.

The IRS noted that since the publication of Rev. Proc. 2009-20, the deaths of some lead figures in Ponzi schemes have foreclosed authorities’ ability to charge them with criminal theft.  Qualified investors in these cases are unable to meet the definition of a qualified loss in Section 4.02 of Rev. Proc. 2009-20 and therefore are precluded from using the optional safe harbor, solely because of the death of a lead figure.  The new revenue procedure expands the definition of qualified loss in Rev. Proc. 2009-20 to address these cases.

The latest revenue procedure also clarifies that the terms “indictment,” “information,” and “criminal complaint” in Section 4.02 of Rev. Proc. 2009-20 have meanings similar to the use of those terms in the Federal Rules of Criminal Procedure.

Last week, a report from the Treasury Inspector General for Tax Administration found that more than $697 million a year in deductions for investment theft losses may have been erroneously claimed by taxpayers, resulting in a revenue loss of over $41 million to the Treasury (see Taxpayers Wrongly Deducted $700M for Investment Theft Losses).

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