theft/loss

[daisy]

I have a client who I've been very close to for years, good friends. Against my advice he 'invested' in what turned out to be a Ponzi scheme. The money was invested in 2006, the scam was exposed in 2006, the guy was arrested in 2006, and has since been sentenced to 10 years in prison. The judge decided against the longer sentence so he can get out and start paying these people back.

My client is in a bad spot financially right now, not from the scam, but due to leaving his job to explore other opportunities. So, I told him we should amend his return and file the $15,000 as a theft, get a small, but substantial to him now, amount back and then if/when he gets paid back, we'd just claim the income.

They recovered $1 million from selling this guys stuff, but he owes $4 million, in that $4million is my client's $15,000. He was told to expect a small amount at first, then when the guy gets out of prision, in 10 years, he's ordered to pay everyone back, the 'investors' were told, to expect very small amounts at a time, since the after prison payments will probably be coming from a paycheck garnishment, and that paycheck garnishment will be split up among all the victims.

I explained to client, that he may never get all of his money back, chances are good that he won't, he said the list of people this money is getting split up between is 5 pages long and many of them invested more than he did, so they will get a higher percentage of available funds.

Today he told me he doesn't want to file form 4684, because he feels that this is not legal to do, since a Federal court ruled that this guy must pay back all the money, he also feels that since a Federal court ruled that this money has to be paid back, that it *will* get paid back, he's not listening to me telling him it's likely he won't get all his money back.

he feels filing 4684 "screams AUDIT!" his words, in an e-mail to me.

I wrote him back, explaining the time limit on refunds and he may lose out on this and this is not illegal, and won't *flag* an audit.

Does anyone have experience with these schemes and taking it as a theft? I just know this money would help him out so much right now, but I can't force him to claim the theft. the small amounts of money he's going to be getting each year, he won't even notice the tax difference adding it to his income as he gets reimbursed, because when he works he makes a really really good living. He just really feels this is illegal and doesn't want to get audited.

I guess there's nothing I can do, I just felt like getting this out. Am I correct, in saying a 4684 is the way to go?

Thanks.

[TaxmannEA]

I would tend to go with your client's wishes on this one. While he probably was a victim in this scheme, his investment isn't totally worthless and the actual amount of loss is not determined yet. When he receives any restitution, it won't be taxable until the recovery exceeds his investment (I can dream, can't I?) so it won't increase his income at that point. The problem is that this would be a capital loss only when you can say with certainty that the "investment" is worthless, and that may be a while in the future.

(I often wonder if you could write these things off as educational expense.)

[OldJack]

I would look closer at the paperwork. You said there was an "investment" and I would expect that the investment is in fact worthless and might be written off. The fact that an individual might make restitution is immaterial to the original investment instrument. Also, if your client "invested" in a debt instrument or stock I would not think it was a theft, rather it is a worthless security of a business that had a theft.