This article is accompanied by a video on The Lehman Tax Law Library at
Website: https://thelehmantaxlawlibrary.com/
Youtube Channel: https://www.youtube.com/channel/UCTH1JITaiKhUSC3MTxFVXYg
These videos are a short-cut to understanding the most important tax law changes resulting from the Trump legislation, but a more thorough review may be required to fully understand the content.
The new Trump Tax Cuts affects Ponzi Scheme losses to one degree or another. It appears at first glance that one of the few areas of the new law that may have lost value due to the Trump Tax Cuts from a tax standpoint, is the Ponzi scheme deduction for losses incurred in the scheme. The new Trump Tax Bill will make Ponzi Scheme theft losses less valuable to many victims of financial thefts.
For many people their tax refunds from Ponzi Scheme losses may be limited. After having lost assets in the Ponzi Scheme, the victim of the Ponzi Scheme may be very likely to have a reduced fortune, in a lower tax bracket due to the effect of the theft loss.
It could very well be that a Ponzi Scheme victim may have reported income in years prior to 2018 and paid a 50% tax on their false investment profits between city, state and federal income taxes. In the event these taxpayers lost money and have been injured, they now may be in a lower tax bracket and unable to take full advantage of the loss. This is because loss carrybacks have been eliminated as a potential deduction and tax rates from 2018 forward are greatly reduced in many cases.
No Loss Carry Backs
Under the Trump Tax Cuts, there no longer is the ability to carry back losses to prior years to obtain deductions and tax refunds. There no longer is a “loss carryback deduction”. Loss carry forwards are allowed ad infinitum. Under the new Trump Tax Cuts, losses can be carried forward indefinitely. However, a taxpayer can no longer collect tax refunds from past Ponzi scheme losses that are first reported in 2018 and thereafter.
Individuals who have had losses from financial thefts and other theft losses in 2015, 16 and 17 will need to be careful to take advantage of any tax loss carrybacks that still may be available to these taxpayers.
Not only will Ponzi Scheme losses not be available for use in prior years; taxpayers may have to wait far into the future to recoup Ponzi Scheme losses from tax refunds if their incomes have decreased and they cannot make present use of the otherwise valuable tax losses.
Ponzi Scheme Theft Loss
Ponzi Scheme Theft Losses may have become less valuable for tax purposes because of the Trump Tax Cut and Jobs Act that was signed into law in December of 2017. That tax bill lowered tax rates in the future and also reduced the value of Ponzi theft loss deductions by eliminating the right to carry back losses and receive tax refunds from earlier years. Loss carrybacks have been eliminated. There are only loss carry forwards available from 2018 forward.
What this could mean, (for example) is the following:
The “Profits Years”
Assume a wealthy investor had profited from Ponzi Scheme income in one of the states with high taxes and in a tax year where that total income tax was more than 50% due to the effect of the combined top rates of say New York City, State and Federal income taxes on Ponzi Scheme $500,000 of earnings per year. Assume this occurred every year for three years starting in 2015. The Taxpayer will pay total taxes of $750,000 over the three-year period (2015 to 2017) on the profits.
Assume in 2021 that taxpayer learns that the $1,500,000 in profits for the years 2015, 2016, and 2017 was illusory and never existed. Assume in 2021 that the taxpayer now has a theft loss deduction of $1,500,000 because the gross profits were left in the Ponzi Scheme and ultimately lost by that taxpayer. Now, assume that by 2021 the taxpayer has retired to one of the United States that has no city or state income taxes; and assume the retired taxpayer has a reduction in income and now pays taxes in the 20% tax bracket. As a result of the new tax cuts, the Ponzi theft loss deduction that is allowed on the $1,500,000 loss may be worth only $300,000 in refunds at a 20% tax rate.
The taxpayer in this example will have paid taxes on taxable income equal to fifty cents on a dollar ($750,000), and will receive tax refunds at twenty cents on the dollar, ($300,000). Furthermore, the taxpayer may need to wait many years into the future since there is less taxable income in each of the later years upon which to collect the refund.
The Taxation of a Clawback of Principal (not Profits) from a Ponzi Scheme
In certain instances, profitable investors in a Ponzi Scheme can lose a portion of their original principal in a Clawback “of principal”. A portion of the investor’s principal may have been distributed to the investor shortly before the Ponzi Scheme was discovered. Often if the taxpayer has received their principal from the Ponzi Scheme shortly before it collapses, the law may permit a Trustee to clawback that investor’s principal investment. It is unusual but it does happen.
Under these circumstances, a principal investment in a Ponzi Scheme is treated the same as a direct loss in a Ponzi Scheme. This means that taxpayers who suffer a Clawback of principal will only be allowed to treat their Clawback as a deduction. They will have no use of the “Mitigation Section”, since there will not have been a tax loss of profits.