Monday, July 2, 2012

White Collar Crime Victims - Fraud Tax Loss

“White Collar” Fraud manifests in a myriad of ways, including, but not limited to the following:

1. “Ponzi Schemes,” sometimes referred to as “First In, First Out” or Vertical Marketing Fraud
2. Real Estate Fraud
3. Securities Fraud
4. Internet Fraud
5. Entertainment-Related Fraud

For United States citizens and/or other individuals who are required to file Federal Tax Returns and who may have been a victim of fraud, there may be available to them a vehicle to mitigate their fraud loss by way of an income tax loss defined as a “theft loss” subject to a “casualty loss deduction.”

To obtain this benefit, the taxpayer would be required to initiate litigation against the party, parties, entity or entities who perpetrated the fraud in the first instance.  The initiation of a complaint to recover the fraud losses creates an income tax deduction which may generate tax refunds which can offset the cost of the litigation.  Taxpayers need not prevail in the underlying litigation in order to generate those tax refunds.

Income Tax planning strategy includes tax savings, tax refunds, tax-free income.

1. Tax Savings - 41% Federal/California income tax savings (“Blended Tax Rate”). For example, a $5 million fraud lawsuit from theft may support a $5million tax loss generating $2.05 million in income tax savings.
2. Tax Refunds – Under IRC§172(b)(1)(F), the tax loss (for theft) may be “carried back” for 3 years (by filing form 1040x, IRS). Any income taxes paid during the 3 prior “carry back years” may be subject to refund.
3. Tax-Free Income – The tax loss for theft may be carried forward for up to 20 years under IRC§172, offsetting taxable income which may create “tax-free” income.

Casualty/Theft Loss (Federal Law)

Theft Defined.
Theft is the illegal taking of money or property with the intent to deprive the owner of it. (W. Lafave, Criminal Law section 8.5, at 721 (2d Ed. 1986)).  Theft includes, but is not limited to, larceny, embezzlement, and robbery. (Reg. Section 1.165-8(d)).

Federal Law.
In the case of Gerstell (Petitioner) v. Commissioner of Internal Revenue (Respondent) 46 T.C. 161 (Docket No. 4299-64, filed May 4, 1966), the Tax Court States (at Page 7):

Section 165 of the Internal Revenue Code of 1954 provides for the deduction of losses arising from theft.  The term Theft . . . converting any criminal appropriation of another’s property to the use of the taker, particularly including theft by swindling, false pretenses, and any other form of guile.

It has been held that a criminal conviction is not a necessary element in a Taxpayer’s proof that a theft loss has been sustained. (See: Michele Montelone 34 T.C. 688 Paul C.F. Vietzke 37 T.C. 504)

Whether a loss arises from theft depends upon the law of the jurisdiction where the loss was sustained.  Edwards v. Bromberg (C.A. 5) 232 F. 2d 107

California Penal Code Section 484(a)
Under California State Law, California Penal Code Section 484(a), theft is defined to include fraud:

Every person who shall feloniously steal, take, carry, lead, or drive away the personal property of another, or who shall fraudulently appropriate property which has been entrusted to him or her, or who shall knowingly and designed by, any false or fraudulent representation or pretense, defraud any other person of money, labor or real or personal property, or who causes or procures others to report falsely of his or her wealth or mercantile character and by thus imposing upon any person, obtains credit and thereby fraudulently gets or obtains possession of money, or property or obtains the labor or service of another, is guilty of theft.

Statement of Federal Law: Theft Losses (Summary).
IRC § 165(a) provides as a general rule that “any loss sustained during the taxable year” may be deducted if it is not compensated for by insurance or otherwise.

Theft Loss Tax Deduction
(IRC §165(c)(2)(3))

Under IRC §165, an individual may deduct losses arising from “fire, storm, shipwreck, or other casualty or from theft.”

Under IRC §165(c)(2), an individual may deduct theft losses involving a transaction entered into for profit.

Under IRC §165(c)(3), an individual may deduct losses due to theft (see Treas. Reg. Section 1.165-8(d)).

A loss arising from theft is treated as sustained during the taxable year in which the Taxpayer discovers the loss (IRC §165(e)(1)).

The deductible amount is the lesser of the fair market value or basis of the property stolen (Treas. Reg. §1.165-8(c)), IRC §165(b).

An individual is permitted to deduct losses to her property arising from “fire, storm, shipwreck, or other casualty, or from theft.” The term “other casualty” defined as a sudden, unexpected event that is unusual in nature and beyond the control of the taxpayer.

A theft loss technically is not a casualty loss, but theft losses are aggregated with casualty losses for most purposes. The first $500 (2009) of each personal casualty or theft loss is not deductible, and personal casualty and theft losses are generally deductible only to the extent they exceed 10 percent of the taxpayer’s AGI.

Casualty and theft losses that arise in a trade or business or activity engaged in for profit are deductible (as are other losses arising in these activities).
The portion of a loss that is reimbursed by insurance is not deductible (Code Section 165(a)).  A personal casualty or theft loss is deductible only if the taxpayer files a timely claim for any insurance covering the loss. Code Section 165 (h) (5) (E).

Taxpayers claiming casualty and theft losses must file Form 4684, Casualties and Thefts, with their tax returns to claim the deduction. The IRS has also made available two workbooks, IRS Publication 584, Casualty, Disaster, and Theft Workbook, and IRS Publication 584B, Business Casualty, Disaster, and Theft Workbook, which contain schedules used to compute personal and business casualty and theft losses, respectively.