April 22, 2010 - Robert J. Packard
The Internal Revenue Code allows taxpayers to deduct from their taxable income losses of property that are due to theft and/or fraud, even if these losses are not connected to a trade or business. This type of loss is known as a personal casualty loss. Our tax attorneys and lawyers understand how and when you can take the fraud loss deduction.
To properly take the deduction, the taxpayer must show that the loss (1) was due to theft, and (2) was discovered in the year in which the taxpayer is taking the deduction. The taxpayer also must be able to show, through sufficient documentation, the amount of the loss, and that in the year the loss was discovered, there is no reasonable prospect of recovering any portion of it.
Proving that a loss was caused by theft can sometimes be difficult, however, because theft is what is referred to as a "specific intent" crime. Suppose, for example, that you own stock in a corporation. Suppose further that one of the directors of this corporation commits some type of fraud against the corporation, resulting in the partial or even total worthlessness of your stock. You would not be allowed to deduct the lost value of your stock as a theft loss, because in all likelihood, you cannot show that this director specifically intended to decrease the value of your stock.
Fortunately, the IRS has issued several rulings to help investors in situations similar to this. The gist of these rulings is that when the director of a corporation or investment scheme commits criminal fraud, the taxpayer can often treat his loss as a fraud loss, even though he may not be able to show that the director had any specific intent to commit fraud against him in particular. When certain circumstances are in effect, the taxpayer need not even show that the director was convicted of fraud, only that he or she has been the subject of a criminal complaint. These rulings can be especially valuable to taxpayers who have lost money in entities that have been determined to be "Ponzi" schemes. The IRS has issued specific guidance for such investors, and as long as certain requirements are met and certain disclosures are made, the taxpayer can deduct from his gross income the amounts that he has lost due to fraud, subject to certain limitations. This type of deduction can significantly decrease your tax liability for the year.
The facts and circumstances of each case are important, but even if the theft in your case was not deemed to be a Ponzi scheme, or even if the person who stole from you has never been the subject of a criminal complaint, you may still be able to deduct a significant amount.
If you feel you may have a situation that qualifies for a theft or fraud loss deduction, please make an appointment to consult with one of Robinson and Henry's tax attorneys. We are eager to help you with these types of problems.
IRS CIRCULAR 230 DISCLOSURE STATEMENT: The advice, if any, contained in this correspondence and its attachments or enclosures is...