Since it’s confirmed that it’s all a scam, will the investors get a refund on the taxes they paid from the false gains?
Some may find relief, but the law isn’t always on the side of investment victims. I keep this linked article in my bookmarks as part of my reference materials: No Theft Loss for “Phantom” Income
It’s a different case from the 90’s, but very similar to the Madoff one. The courts limited the taxpayer’s ability to claim losses for “phantom” income or the taxes paid on it. In essence, the conclusion was that the income never existed so the only theft was the original investment. The non-existent income should be removed from returns by amending them, but you can only receive a refund for amendments within three years.
The Madoff case is big enough that some sort of special relief may come down the pipe, but barring that, I think the treatment would be as follows:
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For open tax years (i.e., those not barred by the statute of limitations, so the last 3 years), taxpayers can file amended returns zeroing out the income they reported on Madoff’s investments.
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Investors can claim a loss this year for the full amount they invested minuse any they recovered.
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Other than that (i.e., income reported in closed years), the investors are SOL.
How was Madoff reporting income to his investors? As interest and/or dividends as opposed to capital gains?
Considering this was a Ponzi scheme and not an investment, though, there are bound to be complications. Can anybody provide some clarification?
A, B, C and D all pay into the Ponzi scheme. B, C and D don’t realize it, but their money has gone to A, who has withdrawn some of his “profits.”
A files his taxes and reports these as “profits” which … I’m no tax expert, but I suppose there are different types of capital gains and income, and rates at which each are taxed.
In actuality, the money from Madoff wasn’t a capital gain or income at all, but a gift, right? There was never any investment, so that rule doesn’t seem to apply (at least in my mind).
Is this statute of limitations the same for all tax purposes? I was under the impression that taxpayers should keep their documentation for at least 7 years, in case of audits or other tax issues.
If that’s true, it seems pretty crappy that there is such a big discrepancy between the SoL when it benefits the IRS, and the SoL when it benefits the taxpayer.
Except that people generally didn’t take the gift – they kept it with Madoff.
Generally, your dividend income is reported to the IRS and you must pay tax on it, even if you don’t cash the stock. Most of the time, this is a good arrangement – better to have to pay tax on $1000 in dividends for ten years in a row, then getting stuck with the tax on $10,000 in dividends when you cash things in after ten years.
Madoff duly “reported” dividends and people paid tax. Since the dividend amounts were bogus, you can fill out an amended tax return to fix that.
The system assumes no long-term fraud, so this is outside of what usually works pretty well. The three-year statute of limitations is to avoid people saying “Hey, I’ve been making mistakes for a decade and want things fixed.” The incentive is to get things right the first time and, other than fraud, you usually can.
Thank you for the clarification. However, I specifically meant if A withdrew some money. Would it technically be a gift, since there was no actual investment taking place?
No. For tax purposes, a gift must be given with “detached and disinterested generosity” on the part of the giver (to, for example, distinguish between a gift and a “gift” given to someone who referred you a lot of business–which looks like, and should be treated as compensation for services.)
Whatever Madoff’s intentions were, and whatever the tax treatment of the payments were, he clearly wasn’t just trying to be generous clearly was not aiming to be generous, or disinterested–he wanted to avoid getting caught. It won’t be a gift.
A bit of a hijack, but I beg to differ. I would much rather pay the tax at the end - and make money in the meantime by earning interest on the portion I have not yet had to pay to the IRS.
Considering the folks that got screwed tended to be on the wealthy side, I suspect we’ll see an tagalong on some bill soon giving them all of their tax money back. I wouldn’t doubt that several are heavy political contributors.
The income tax statute of limitations (26 usc 6501) provides that generally the IRS must act within 3 years of a return. However, where there is a “substantial omission” of more than 25% of gross income, the IRS has 6 years. If no return was filed or there was fraud on the part of the filer, there is no statute of limitations.
The 7 year advise is to make sure documentation is available if the IRS comes to you with a substantial omission claim.
Here is an article regarding income tax and Madoff’s victims.
(first paragraph only)
If they actually took money out, then they’ve got an actual realized gain. Why wouldn’t they pay income tax on that?
If they were automatically reinvesting dividends with Madoff, such that they’ve been paying taxes but not actually receiving any money, that seems like a more difficult case.
And if Madoff was simply reporting an unrealized capital gain, then they never got money but presumably also never paid tax.
I agree that they would realize an actual gain. But what kind of gain is it?
Scenario 1. You give money to a broker, who invests it. After 1 year you withdraw some money.
Scenario 2. You give some money to some guy. After 1 year he gives it back to you with a small bonus.
Now I have no idea if there’s a legal difference here between the different types of income. Are they different types of income? Are they taxed at different rates?