Interesting concept to watch. I think it could be argued definitely for some of the Enron-ish stocks, but I also think it would cost more than most people would gain to defend it under the sure to come audit. And by the time some case gets successfully defended as a precedent, the window to try to take the theft losses from the bubble will be past.
By the way, I think the 3k limitation is greatly unfair to the individual investor. The Government likes to be your risk free partner when you make investment gains, but doesn't want to share in the losses. I know some people who would love to be able to carryback their losses and refile for about 3 prior years. And such an "allowance" would probably get the economy going better than most of the other current tax changes. Get the consumers savings back to him/her now rather than dribbling it back over the next X number of years.
Its not like the government isn't already spending grossly more than it collects in taxes anyway. What's another drop in the bucket.
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CBS MarketWatch
When might stock losses count as a theft claim
Friday February 13, 3:42 pm ET
By Eva Rosenberg
Company malfeasance opens door to casualty-loss claim
LOS ANGELES (CBS.MW) -- Over 15 million taxpayers filed tax returns with capital-loss carryforwards of more than $314 billion in tax year 2000, according to the IRS.
Many of those capital losses arose from stocks like Enron, Tyco or WorldCom, where accounting fraud and other wrongdoing has led to criminal charges and convictions.
Those capital losses are of little benefit, though, unless you also have capital gains. That's because only $3,000 of capital losses over and above capital gains can be used each year to offset ordinary income. Although you can carry over excess capital losses to future years, taxpayers who have few future capital gains are stuck with the $3,000 excess limit.
But there may be a way, albeit a risky and untested one, for taxpayers victimized by scandal-plagued companies to make better use of those capital losses.
Roger B. Adams, an international tax practitioner and manager of the Volunteer Embassy and Consulate Tax Assistance program at the U.S. Embassy in Lisbon, Portugal, uncovered a heartbreaking investment loss case: Nearly $700,000 of his client's money was stolen by a friend who lied about a non-existent investment fund.
This case prompted Adams to research the idea of taking a casualty loss for the investment rather than a capital loss.
The tax-code definition of a casualty does clearly include theft. So, if Adams could prove the theft, his client could recoup some his losses by treating them as a casualty loss instead of an investment loss. He could deduct the full amount of the loss against the current year's tax return.
Losses in excess of his current year's income could be carried back to three years earlier as a net operating loss. Anything left over after that could be carried forward for 20 years and used to wipe out each year's income until the loss was used up. Due to recent legislation, losses in 2001 and 2002, may be carried back for 5 years.
Risky business
Doing the research, it occurred to Adams "that the tax treatment of this case has extremely far-reaching implications. What about the billions in losses sustained by investors in Enron and WorldCom? There is evidence of fraud..."
Sending out a detailed, annotated explanation to a select group of tax professionals, Adams found the consensus was that they loved the idea. None had made the connection before. Some wanted more research before applying the principals. All agreed the logic was flawless.
The problem is the IRS officially hates the idea.
After spending months pestering the IRS for a formal comment on this treatment of the stock losses, IRS officials gave us this warning:
"This article is not correct and the issue of stock losses producing theft losses has been litigated a number of times," IRS officials said.
"It is true that the word 'theft' is broadly defined, but a taxpayer must show theft under the specific state law governing the transaction. Generally, the decline in the value of stock does not qualify as theft loss and specifically no taxpayer that bought stock on the open market has ever qualified for a theft loss under the case law.
"This is because a theft requires specific intent to deprive that taxpayer of his or her money and there is no privity between the person making the misrepresentation and the person who purchased the stock on the open market.Â
"Normally, under state law, the person who makes the misrepresentation must also wrongfully take or expect take the victim's money. This is also lacking when the stock is purchased on the open market.
"Also, the amount of a loss ... must be established with reasonable accuracy and theft stock losses have been denied because the taxpayer cannot show that all of the decline of the stock was attributable to the misrepresentation rather than other problems with the company.
"Finally, stock theft losses have been denied because the taxpayer did not establish that there is no possibility of reimbursement through litigation or otherwise. As a result, a taxpayer must normally wait until the stock becomes completely worthless under section 165(g). This requires total worthlessness including potential worthlessness," IRS officials concluded.
Now we know how to file
If you're faint of heart, stay away from this aggressive position. If you're bold, you've just gotten a great starting point for your amended return. Reading the IRS's objections makes it clear that a well-prepared file has the chance of succeeding in getting the claim accepted.
You'd have to start with a stock that was either sold, taken, stopped trading or was officially declared worthless. Avoid filing these claims for stocks you still hold in your portfolio.
Then, do some digging to prove the stock value tanked because of the officers', auditors or company's criminal actions.
If there is litigation pending, get a good estimate of what your net proceeds might be from that litigation and deduct it from your claim at the outset. Do some research and get information about historic payouts, after all the legal costs have been deducted. They're usually pennies on the dollar.
If the litigation settles during the three years after you've filed your amended return, and you get much less than you projected, you can amend that amended return to collect the difference.
And, to address the IRS' point about privity, do some research on accounting firms that have paid out major settlements to investors who lost money on corporate stock without ever having seen or read the firm's audit report The firms whose audit reports were misrepresented had even less privity than the corporate officers, yet the courts found in the investors' favor.
If you think you have a case, file it before the statute of limitations expires. Even if the IRS doesn't accept your amended return, filing the claim protects your right to collect when the IRS finally does lose on this issue. And they will.
Greg Kahn, director of international finance at Sicor Inc., suggests even more far-reaching benefits. "You make a lot of sense. It will not only raise the interest of Congress and U.S. Treasury, but also of the Justice Department and whether different terminology will be used in accusing cases of mismanaged corporate governance."
Roger Adams' original case, the clients who lost nearly $700,000 due to the friend's lying about the investment fund, would clearly survive IRS' objections, as stated above.
Frankly, now that we have the IRS arguments in hand, the feeling is the IRS' case can be defeated by anyone who puts in the research time. Do work with a tax professional familiar with audit, appeals and tax court procedure.
Take all proper precautions -- and don't use this position unless you're ready for a fight. But, if you've already lost it all...what else do you have to lose, but your time? |
