The Internal Revenue Code often
requires the calculation of amounts that are less
than absolute but more than mere guesses. IRC §
165 allows taxpayers to deduct theft and other
casualty losses but requires them to take
reasonable action to recover those losses. If a
claim for reimbursement has a reasonable prospect
of recovery, the loss is not treated as sustained
“until the taxable year in which it can be
ascertained with reasonable certainty whether or
not such reimbursement will be received.” Treas.
Reg. § 1.165-1(d)(3); see also Jeppsen v.
Commissioner , 128 F.3d 1410 (10th Cir.
1997).
“INCORRIGIBLE OPTIMISM ” NOT REQUIRED
What is reasonable
certainty? “A reasonable prospect of recovery
exists when the taxpayer has bona fide claims for
recoupment from third parties or otherwise, and
when there is a substantial possibility that such
claims will be decided in his favor.”
Jeppsen, quoting Ramsay Scarlett
& Co. Inc. v. Commissioner, 61 TC 795,
811 (1974), aff’d, 521 F.2d 786 (4th Cir.
1975). The taxpayer is not required to be an
“incorrigible optimist,” United States v. S.S.
White Dental Mfg. Co., 274 U.S. 398, 402–03
(1927), and claims with only “remote or nebulous”
potential will not postpone the deduction
(Ramsay Scarlett). Whether a reasonable
prospect of recovery exists is determined by
reviewing all facts and circumstances. Treas. Reg.
§ 1.165-1(d)(2)(i).
“CREDIBLE EVIDENCE ” REQUIRED
It is settled law that deductions
are a matter of legislative grace, and the
taxpayer must prove that he or she is entitled to
the claimed deductions. INDOPCO Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New
Colonial Ice Co. v. Helvering, 292 U.S.
435, 440 (1934). “The law does not require that
they [damages] be determined with mathematical
certainty. It only requires that damages be
capable of measurement based upon known reliable
factors without undue speculation.”Ashland
Management Inc. v. Janien, 82 N.Y.2d 395,
604 N.Y.S.2d 912 (1993). A taxpayer must
provide the IRS with “credible evidence” of an
amount for which it is “reasonably certain” that
the loss will be sustained, before a theft loss
amount may be deducted. If a client claimed a loss
under IRC § 165, and the reimbursement exceeded
what was estimated, that portion of the
reimbursement that was previously deducted under
IRC § 165 will be treated as ordinary income for
tax purposes. The reimbursement that exceeds the
adjusted basis will be treated as a capital gain.
Because the IRC takes into account the possibility
that the expected reimbursement may turn out to
have been inaccurate, it stands to reason that
absolute certainty is not required to take the
deduction.
AN EXPERT OPINION A
recommended practice when submitting a theft loss
deduction is to provide the IRS an independent,
expert opinion as to the amount of the
unrecoverable loss. In Premji v.
Commissioner, TC Memo 1996-304, aff’d, 139
F.3d 912 (10th Cir. 1998), the Tax Court found the
taxpayer’s subjective belief inadequate to sustain
the claim and noted that the taxpayer never
contacted a bankruptcy attorney to ascertain his
chances for a recovery. An expert may be qualified
under the Federal Rules of Evidence: “If
scientific, technical, or other specialized
knowledge will assist the trier of fact to
understand the evidence or to determine a fact in
issue, a witness qualified as an expert by
knowledge, skill, experience, training, or
education, may testify thereto in the form of an
opinion or otherwise, if (1) the testimony is
based upon sufficient facts or data, (2) the
testimony is the product of reliable principles
and methods, and (3) the witness has applied the
principles and methods reliably to the facts of
the case (Fed. R. Evid. 702).
A RECOVERY CALCULATION An
appropriate entity, using an appropriate
methodology, can provide an estimate of the
recoverable portion of a loss, allowing the
taxpayer to file an IRC § 165 claim. In situations
where CPAs represent investors or creditors of
fraudulent or bankrupt enterprises, reasonable
certainty of a prospect of recovery may be based
upon an estimate by a bankruptcy receiver or other
authority of assets available to pay claims in
proportion to the original amount of funds
invested. The IRS should accept a
calculation of this nature as long as it can be
demonstrated that it was accomplished with due
diligence, sufficient data and reasonable
methodology.
By Bart Siegel, CPA, CFE,
MBA, PFS, and president of Siegel Forensic
Accounting and Consulting of Tampa, Fla. His
e-mail address is
bsiegel@tampabay.rr.com. |