Ponzi Scheme Losses

Revenue Ruling 2009-9 provides guidance on determining the amount and timing of losses from these schemes, which is difficult and dependent on the prospect of recovering the lost money (which may not become known for several years).
Go to IRS Website to access Ruling. http://www.irs.gov/uac/Help-for-Victims-of-Ponzi-Investment-Schemes

Revenue Procedure 2009-20 simplifies compliance for taxpayers by providing a safe-harbor means of determining the year in which the loss is deemed to occur and a simplified means of computing the amount of the loss.
Go to IRS Website to access Ruling. http://www.irs.gov/uac/Help-for-Victims-of-Ponzi-Investment-Schemes

Whether a taxpayer who recovers amounts lost in a fraudulent investment scheme is required to include the recovery in income depends on whether the taxpayer claimed a tax deduction for the theft loss in any prior year.
A taxpayer who has not yet claimed a tax deduction for the theft loss is not required to include in income a recovery from the trustee or receiver. Instead, the recovery will reduce the amount a taxpayer may eventually claim as a loss.
A taxpayer who claimed a tax deduction for the theft loss, however, may be required to include the recovery in income, depending on the extent to which the theft loss deduction created a “tax benefit” for the taxpayer.

Under a provision of law known as the tax benefit rule, a taxpayer must include in income the recovery of any amount deducted in a prior taxable year to the extent the prior year’s deduction reduced the taxpayer’s tax liability for that year (or created a net operating loss carryback or carryover

If a taxpayer properly claimed a theft loss deduction and in a later year recovers a portion of the amounts lost, the taxpayer may Not amend the prior year’s income tax return to reduce the theft loss deduction by the amount of the recovery. Instead, the recovery is includible as tax benefit income in the year received.

See Revenue Ruling 2009–9 and Revenue Procedure 2009-20.

The scheme is named after Charles Ponzi who became notorious for using the technique in 1920.
In March 2009, Bernard Madoff pleaded guilty to 11 federal felonies and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors of billions of dollars.
A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, instead of from profit earned by the individual or organization that is running the operation.
The scheme usually entices new investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent. Perpetuation of the high returns requires an ever-increasing flow of money from new investors to keep the scheme going