Ponzi-scheme theft loss was discovered when a lead figure died and a receiver was appointed

Plain-English summary

A taxpayer invested in an alleged fraudulent arrangement involving multiple lead figures and claimed a theft loss under the Ponzi-scheme safe harbor. In one year, a government agency filed a civil complaint alleging substantially all elements of the fraudulent arrangement, one lead figure died before criminal charges could be filed, and a receiver was appointed. Another lead figure was criminally charged in a later year. Chief Counsel concluded that the earlier year was the discovery year under Revenue Procedure 2011-58. The later criminal charge did not postpone discovery because the civil complaint, death, and receivership already satisfied the modified safe-harbor requirements.

Ruling snapshot

• Question: Which year was the discovery year for a Ponzi-scheme theft loss when one lead figure died and another was charged later?
• Outcome: Advice given
• Key authorities: IRC § 165; Treas. Reg. §§ 1.165-1 and 1.165-8; Rev. Procs. 2009-20 and 2011-58

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201511018
       Release Date: 3/13/2015
       CC:ITA:B02:HFRogers
       GL-124835-14

UILC: 165.00-00

date: November 20, 2014

 to:   Robert Romashko General Attorney (Chicago)
       (Small Business/Self-Employed)
       CC:SB:4:CHI:1

from: Norma C. Rotunno
Senior Technician Reviewer, Branch 2
(Income Tax & Accounting)

subject: Year to deduct theft loss

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

       Taxpayer                                     =        ------------------------------------------------
       A                                            =        ---------------------------
       C                                            =        ---------------------------------------
       D                                            =        ---------------------
       E                                            =        -----------------------------------------------
       Year 1                                       =        -------
       Year 2                                       =        -------
       Year 3                                       =        -------
       Year 4                                       =        -------
       Year 5                                       =        -------
       Date X                                       =        ---------------------
       Agency                                       =        ---------------------------------------------------------------
         ------------------------------------------------------------------------------------------------------------------
       Month Y                                      =        ------
       Month Z                                      =        ----------
       a                                            =        ------------

GL-124835-14 2

b = ----------
f = -----------------------------------
g = ----------------------------
Allegation 1 = --------------------------------------------------------------

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Allegation 2 = -----------------------------------------------------

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ISSUE

What year is the proper year of discovery for Taxpayer’s theft loss claim under Revenue
Procedure 2009-20, as modified by Revenue Procedure 2011-58, where there are
multiple lead figures and one lead figure dies before being criminally charged and
another lead figure is criminally charged in a later year?
GL-124835-14 3

CONCLUSION

Based on the facts provided, the proper discovery year for Taxpayer’s theft loss is Year
4, the year in which: a. the civil complaint was filed by the Agency that alleged facts that
comprise substantially all of the elements of a specified fraudulent arrangement
conducted by the lead figures; b. one of the lead figures died before being criminally
charged; and c. a receiver was appointed with respect to the arrangement.

FACTS

In Year 2, Taxpayer wrote a check payable to D for $a to purchase four f. In Year 3,
Taxpayer wrote two checks payable to E totaling $b to purchase additional f. One lead
figure, A, was the owner or part owner of several companies, including C.

During Year 4, the Agency was trying to contact A as a result of several complaints they
had received. A died in Month Y Year 4. On Date X, the Agency filed a civil complaint
against the lead figures, including the estate of A, as well as several related companies
the lead figures owned and controlled. The civil complaint alleged that the lead figures
engaged in -----------------------------------------------from Year 1 through Month Z Year 4.
Taxpayer invested in the -----------------, in which the lead figures offered investors f
through D and C. The Agency complaint also alleged that Allegation 1. Based on these
allegations, the Agency asserted several violations ------------------------.

The Agency moved in court for the appointment of a receiver. A receiver was appointed
in Year 4 to recoup money and any other assets from the lead figures and the entities
they owned, operated or controlled.

During Year 5, another lead figure was ----------------------------------------------------------------

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Taxpayer claimed a theft loss in Year 4 using Rev. Proc. 2011-58. Exam has asked for
advice on whether the year of discovery under Rev. Proc. 2011-58 is Year 4, when one
lead figure died, a civil complaint was filed by the Agency, and a receiver was
appointed, or Year 5, when criminal charges were filed against another lead figure.

LAW AND ANALYSIS

Section 165(a) of the Internal Revenue Code allows a deduction for losses sustained
during the taxable year and not compensated by insurance or otherwise. A loss arising
from criminal fraud or embezzlement in a transaction entered into for profit is a theft
loss, not a capital loss, under § 165. Rev. Rul. 2009-9, 2009-14 I.R.B. 735.

Section 165(e) states that any loss arising from theft shall be treated as sustained in the
GL-124835-14 4

taxable year the taxpayer discovers the loss. Under §§ 1.165-8(a)(2) and 1.165-1(d),
however, if, in the year of discovery, there exists a claim for reimbursement with respect
to which there is a reasonable prospect of recovery, no portion of the loss for which
reimbursement may be received is sustained until the taxable year in which it can be
ascertained with reasonable certainty whether or not the reimbursement will be
received. Whether a reasonable prospect of recovery exists is a question of fact to be
determined upon examination of all facts and circumstances.

Revenue Procedure 2009-20

Rev. Proc. 2009-20, 2009-1 C.B. 749, provides an optional safe harbor treatment for
taxpayers that experienced losses in certain investment arrangements discovered to be
criminally fraudulent (so-called “Ponzi” schemes). The procedure provides investors
with uniform and simplified methods for determining the timing and amount of a theft
loss deduction. Rev. Proc. 2009-20 applies to losses for which the discovery year, as
defined in § 4.04 of Rev. Proc. 2009-20, is a taxable year beginning after
December 31, 2007.

Section 4.03 of Rev. Proc. 2009-20 defines a qualified investor as a United States
person, as defined in § 7702(a)(30) --

(1) That generally qualifies to deduct theft losses under § 165 and § 1.165-8;

(2) That did not have actual knowledge of the fraudulent nature of the investment
arrangement prior to it becoming known to the general public;

(3) With respect to which the specified fraudulent arrangement is not a tax shelter, as
defined in § 6662(d)(2)(C)(ii); and

(4) That transferred cash or property to a specified fraudulent arrangement. 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. However, the fund or entity itself may be a qualified
investor within the scope of the revenue procedure.

Section 4.01 of Rev. Proc. 2009-20 defines a specified fraudulent arrangement as an
arrangement in which a party (the lead figure) receives cash or property from investors;
purports to earn income for the investors; reports income amounts to the investors that
are partially or wholly fictitious; makes payments, if any, of purported income or principal
to some investors from amounts that other investors invested in the fraudulent
arrangement; and appropriates some or all of the investors' cash or property.

Section 4.02 of Rev. Proc. 2009-20 defines a qualified loss as a loss resulting from a
specified fraudulent arrangement in which, as a result of the conduct that caused the
loss --
GL-124835-14 5

(1) The lead figure (or one of the lead figures, if more than one) was charged by
indictment or information (not withdrawn or dismissed) under state or federal law with
the commission of fraud, embezzlement or a similar crime that, if proven, would meet
the definition of theft for purposes of § 165 and § 1.165-8(d), under the law of the
jurisdiction in which the theft occurred; or

(2) The lead figure was the subject of a state or federal criminal complaint (not
withdrawn or dismissed) alleging the commission of a crime described in section 4.02(1)
of this revenue procedure, and either --

(a) The complaint alleged an admission by the lead figure, or the execution of an
affidavit by that person admitting the crime; or

(b) A receiver or trustee was appointed with respect to the arrangement or assets of the
arrangement were frozen.

Section 4.04 of Rev. Proc. 2009-20 states that a qualified investor's discovery year is
the taxable year of the investor in which the indictment, information, or complaint
described in the definition of qualified loss under § 4.02 is filed.

Revenue Procedure 2011-58

The Service and Treasury issued Rev. Proc. 2011-58 to address situations in which the
death of lead figures in certain Ponzi schemes prevented government authorities from
charging them with criminal theft. Rev. Proc. 2011-58, 2011-2 C.B. 849, modified the
definition of a qualified loss in Rev. Proc. 2009-20 to include the situation in which the
lead figure or an associated entity involved in the specified fraudulent arrangement was
the subject of one or more civil complaints or similar documents (such as a notice or
order instituting administrative proceedings or other document the Internal Revenue
Service designates) filed by a state or federal governmental entity with a court or in an
administrative agency enforcement proceeding, and all of the following requirements
are satisfied:

(a) The civil complaint or similar documents together allege facts that comprise
substantially all of the elements of a specified fraudulent arrangement conducted
by the lead figure;

(b) The death of the lead figure precludes a criminal charge by indictment,
information or criminal complaint against that lead figure; and

(c) A receiver or trustee was appointed with respect to the arrangement or the
assets of the arrangement were frozen.

Section 4.02(3) of Rev. Proc. 2011-58.
GL-124835-14 6

In addition, section 4.02 of the revenue procedure modified the definition of discovery
year in section 4.04 of Rev. Proc. 2009-20 to include the later of either the year in which
the civil complaint or similar document which alleges facts that comprise substantially all
the elements of a specified fraudulent arrangement is filed, or the year in which the lead
figure dies.

In the instant case, the year of discovery is Year 4 when: a. the civil complaint was filed
by the Agency that alleged facts that comprise substantially all of the elements of a
specified fraudulent arrangement conducted by the lead figures; b. one of the lead
figures died before being criminally charged; and c. a receiver was appointed with
respect to the arrangement.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-7011 if you have any further questions.