Two Out of Three Not Good Enough

The Tax Court ruled that a taxpayer was not entitled to claim a theft loss where he failed to show he had no reasonable chance of recovering his stolen money during the tax year in question.

From 1999 to 2001 Dominick Vincentini, a resident of Michigan, was involved with Anderson Ark, an offshore money laundering operation, in a phony investment scheme to generate artificial tax losses. As a result, Vincentini claimed a $907,470 partnership loss on his 1999 tax return. In 2002 in California and 2004 in Washington state, the operators of Anderson Ark were convicted of numerous federal criminal charges including money laundering, tax fraud, mail fraud and wire fraud. In 2005 the Washington court ordered these individuals to pay restitution to the “investors” including Vincentini. See U.S. v. Keith E. Anderson et al., docket no. 02-cr-423, Western District of Washington (aff’d in part and remanded in part, 9th Cir. 2006).

In 2003 Vincentini received a deficiency notice from the IRS denying the partnership loss deduction. He appealed to the Tax Court. In 2006 while his case was pending, Vincentini filed an amended return for 1999 claiming a theft loss from the investment in Anderson Ark in either 2001 or 2002, which he carried back to 1999. The IRS rejected the amended return, since the tax year was before the Tax Court. The taxpayer then acknowledged he was not entitled to the partnership loss but petitioned the court to allow him to amend his petition to include the theft loss.

The Tax Court originally denied the amended petition. However, at trial the judge reversed the decision and allowed the taxpayer to argue for the theft loss, since the IRS was not prejudiced by allowing the court to consider the issue. Round one to the taxpayer.

The government argued that Vincentini did not suffer a theft loss. Vincentini petitioned the court to reject the government’s position based on judicial estoppel. Under this doctrine, parties are prohibited from arguing a position different from one they argued in earlier proceedings. Since the government had indicted and convicted the Anderson Ark principals of fraud and theft, the Tax Court ruled the IRS could not argue that the taxpayer’s property was not stolen. Round two to the taxpayer.

Under IRC § 165, taxpayers may claim a theft loss if they can prove (1) a theft occurred, (2) the amount of the loss and (3) the year of discovery of the loss. The taxpayer proved items 1 and 2. The government contested item 3, the year of discovery. Under the regulations, if the taxpayer has a reasonable prospect of recovery on a claim for reimbursement by insurance or otherwise, the loss deduction is postponed until it can be ascertained with reasonable certainty whether the recovery will be received. Since the taxpayer was unable to prove that he had no reasonable possibility of recovering some or all of his investments as a result of his failure to pursue his recovery plans completely, he was not yet entitled to a theft loss deduction. Round three and decision to the IRS.

The court then turned to negligence penalties on the return claiming the partnership loss. Since Vincentini did not investigate the rules but relied on the advice of an accountant who worked for Anderson Ark and therefore was not independent, the court found that the taxpayer did not exercise due care. Consequently, the negligence penalty was upheld.

Dominick J. Vincentini v. Commissioner, TC Memo 2008-271

By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accounting, and director, MTA Program, Culverhouse School of Accounting, University of Alabama, Tuscaloosa.