Taxpayers not allowed Ponzi loss safe harbor

The Tax Court holds that the taxpayers had not complied with the conditions of Rev. Proc. 2009-20.
By Charles J. Reichert, CPA

The Tax Court held that taxpayers who were victims of an embezzlement scheme could not use the safe-harbor provision of Rev. Proc. 2009-20 to deduct their theft losses because the taxpayers failed to comply with its requirements. According to the court, the revenue procedure allows the safe harbor only for the tax year a theft is discovered, which occurred before the taxpayers' years at issue.

Facts: In 1999, Michael Giambrone and his brother William founded the Platinum Community Bank in Illinois, which was owned by a holding company, Platinum Bancshares Inc., in which they held a 52.2% ownership interest. The bank struggled financially, so in 2007, stock in the holding company was sold to Taylor Bean & Whitaker Mortgage Co. (TBW) to raise capital. By early 2009, TBW owned an 82.6% interest in the holding company. Lee Bentley Farkas, the majority shareholder of TBW, was named chairman of both the Platinum bank and the Platinum holding company.

Farkas directed TBW to transfer large amounts of its Federal Home Loan Mortgage Corporation (FHLMC) property tax and insurance premium escrow deposits to Platinum. Farkas then directed Platinum to buy $481 million of TBW's mortgage loans. The FHLMC ordered Platinum to sell the loans, and, after failing to do so, it was placed into receivership by the FDIC. In 2010, a federal grand jury indicted Farkas on charges of conspiracy and fraud related to setting up a scheme to misappropriate over $1 billion from TBW, other financial institutions, the FHLMC, and the government's Troubled Asset Relief Program. Farkas was convicted in April 2011.

On their respective 2012 federal income tax returns, the Giambrones used the optional safe-harbor provisions of Rev. Proc. 2009-20 to deduct 95% of the value of their misappropriated investments. In 2018, the IRS denied the deductions and issued a deficiency notice to Michael Giambrone for tax years 2012, 2013, 2014, and 2015, and a notice to William Giambrone and his wife for tax years 2012, 2014, and 2015, assessing additional tax of $1,513,243 and $1,453,008, respectively, and accuracy-related penalties of $302,649 and $290,602, respectively. Both taxpayers petitioned the Tax Court for relief.

The IRS moved for partial summary judgment on the issue of whether the brothers qualified for the Rev. Proc. 2009-20 safe harbor.

Issues: Sec. 165 permits a deduction for theft losses, including those from embezzlement and fraud, if the taxpayer can prove that a theft occurred, the amount of the theft, and the year the theft was discovered. Rev. Proc. 2009-20 provides an optional safe harbor that qualified investors may use to deduct qualified theft losses from a specified fraudulent arrangement.

Rev. Proc. 2009-20 provides that a specified fraudulent arrangement is an arrangement where the lead figure receives cash or property from investors, reports fictitious income, distributes some of the cash received from investors to other investors, and then takes cash or property. Such arrangements often are referred to as "Ponzi" schemes.

A qualified loss is a loss from a specified fraudulent arrangement caused by the actions of the lead figure, where the lead figure is indicted for fraud or embezzlement, or a similar crime, and, if proven, the loss would qualify as a theft loss under Sec. 165.

A qualified investor is a U.S. person eligible to deduct theft losses under Sec. 165 who was unaware of the fraudulent nature of the arrangement prior to its becoming public knowledge.

Under the safe harbor, the deduction is equal to 95% of the amount invested in the arrangement if the investor is not seeking or does not intend to seek recovery from a third party, or 75% of the amount if the investor is seeking or intends to seek third-party recovery. In either case, the loss deduction is reduced by any amounts actually recovered or potentially recoverable from insurance or the Securities Investor Protection Corporation. The deduction must be claimed on the tax return for the discovery year, defined as the investor's tax year in which an indictment, information, or criminal complaint is filed against the lead figure.

The IRS argued that the taxpayers could not use the safe-harbor deduction in 2012 because the year of discovery was 2010.

Holding: The court granted summary judgment in favor of the IRS, holding that the theft losses were not deductible in 2012 under Rev. Proc. 2009-20. According to the court, taxpayers must elect the safe-harbor deduction in the year of discovery, which in this case was 2010, the year Farkas was indicted. The taxpayers argued that the year-of-discovery definition in the safe harbor does not conform to the requirements of Sec. 165 and that they qualified for the safe harbor under the broader language of Sec. 165 and its related regulations.

The court disagreed, stating Rev. Proc. 2009-20 does not have to comply with Sec. 165 because the IRS administratively provided a beneficial treatment for theft losses if certain conditions are met. Taxpayers must meet those conditions to take advantage of the benefit, according to the court. The court stated that further court proceedings would determine whether the taxpayers were eligible to deduct the theft losses under Sec. 165.

  • Giambrone, T.C. Memo. 2020-145

— By Charles J. Reichert, CPA.

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