Ponzi Scam Causes Extra Tax

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Charles Ponzi’s mugshot, circa 1930

A recent court case said that a couple could not deduct a theft loss or recoup tax paid on the disappeared gains from a Ponzi (also known as a pyramid) scam.

The term “Ponzi” started with Charles Ponzi who came to the US in the late 1800’s from Italy. He created a huge scheme, which made him millions (back when that was really a lot of money) but was basically flawed. He needed new money from investors to pay old investors. As long as the fund grew, there was money. But at some point, it all collapsed. That’s what happened in the current tax case.

From 1992 to 2000, Michael and Anita Kaplan had invested $5.7 million with the Ponzi promoter Reed Slatkin. During this time, the Kaplans were told that their funds had earned over $7 million. They reported the income on their tax return and paid tax on it.

Now it was all gone. Or rather, they discovered there never was any gain and they lost the initial investment.

They deducted a little over $6.3 million, representing the initial $5.7 million investment, $519,000 in income they never received and $168,000 in taxes paid.

I understand not being able to get a deduction for the income. It never existed. And the court decision sounds like they will get the deduction for the $5.7 million, just as soon as the final settlements are done and the taxpayers know exactly how much will be deductible.

But, I have to say I’m struggling to understand the Court’s reasoning on the $168,000 in taxes paid on gain they never got. The Court stated that it was up to the Kaplans to prove that the gain had actual in the first place. They couldn’t do that, so there was no refund due. The Kaplans’s next point was that if there was no gain, then no tax was due and so there was an unlawful taking of their money by the IRS. But in a bizarre Catch-22 type decision, the Court found that the Kaplan’s couldn’t prove that the IRS knew it wasn’t gain either.

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