Obviously, get-rich-quick investment scams are much older than that and continue to be a menace for unsuspicious, trusting investors, as well as for the more skeptical ones.

The old, corny saying “if it seems too good to be true, then it probably is” should always make us doubt any “guaranteed risk-free” investment which promises very high returns in the shortest of time.

Con-artists’ ingenuity consists in finding seemingly feasible ideas to attract investors. The initial investment funds are used to attract a second round of investors whose money is used to pay previous investors at the promised return. Most often than not, thinking their money is secure, investors opt to reinvest their money, while in fact there is no real investment at all. The cycle of using investors’ funds to pay previous investors goes on until the whole scheme collapses because of lack of new investors, or because too many investors decide to withdraw their money at the same time.

In the unfortunate event you’ve been the victim of such schemes, it is important to know how and if you are, at least, able to deduct your losses from Ponzi schemes.

If you have a capital loss from your investments in stocks or securities for instance, the IRS allows you to offset the loss but only against your capital gains, plus an additional $3,000 (if married filing jointly) as a deduction against ordinary income.The excess loss can be carried forward, but the loss is subject to a 2% of AGI (adjusted gross income) on miscellaneous itemized deductions, or a 10% of AGI on the deduction for casualty losses. Such deductions are minor when it comes to losses from Ponzi schemes.

In March 2009, in his address to the Senate Finance Committee, IRS Commissioner Doug Shulman announced the following:

“. . . Thousands of Taxpayers have been victimized by dozens of fraudulent investment schemes. These too-good-to-be-true investment uses have often taken the form of so-called “Ponzi schemes” (i.e., the fraud perpetrator promises investments returns, some or all of which are fictitious) . . . The Madoff scandal has affected a very large and diverse pool of Investors, some of whom are reported to have lost most of their life savings . . . To help provide clarity and to assist Taxpayers the IRS is today issuing guidance articulating the tax rules that apply and providing “safe harbor” procedures for Taxpayers who sustained losses in certain investment arrangements discovered to be criminally fraudulent.”

The guidance referred to is Revenue Procedure 2009-20, posted on April 6, 2009. So, let’s take a closer look at what all this means.

Mainly, this revenue procedure provides an optional safe harbor under which qualified investors may treat a loss as a theft loss deduction when certain conditions are met. The revenue procedure is accompanied by a revenue ruling that clarifies terms and the treatment of losses.

• The investor is allowed to deduct 95% of their net investment less the amount of any actual recovery in the year of discovery and the amount of any recovery expected from private or other insurance, such as that provided by the Securities Investor Protection Corporation (SIPC). If the investor is suing persons other than the promoter, than the allowed deduction is of 75%;
  

• A theft loss deduction that creates a net operating loss for the investor can be carried back and forward according to the timeframes prescribed by law to generate a refund of taxes paid in other taxable years;
  

• The investor will have to mark “Revenue Procedure 2009-20” at the top of the Form 4684, Casualties and Thefts, for the federal income tax return for the discovery year.
  

Of course, this is just a simplified summary of the ruling and procedure and, as it is usually the case, help from a specialized tax professional is always the best option in dealing with such matters.

State treatment of such losses will differ from state to state, so further information will be needed.

Even though the Madoff affair is the main reason for the existence of this optional “safe harbor”, the truth is that every year there are numerous general fraud investigations across the country, as you can see from the IRS annual list of examples.

It is obviously preferable you never get involved in such schemes and protect your investments from fraud.

Don’t hesitate to ask professional, trustworthy advisors to help you with your investments. Keep safe and good luck!