Estate can take theft loss deduction related to Madoff Ponzi scheme.

• Author: Beavers, James A.
• Position: Bernie Madoff

Bernie Madoff admitted that Madoff Securities was a massive Ponzi scheme and pleaded guilty to various federal crimes.

An estate's loss "arose from" a Ponzi scheme, so a theft deduction was allowed; the 1RS acquiesces to applying the mortgage interest deduction limit on a per-taxpayer basis.

The Tax Court held that an estate could take a Sec. 2054 theft loss deduction where a Ponzi scheme rendered an interest in an LLC the estate owned worthless.

Background

James Heller, a resident of New York City, died on Jan. 31,2008. At that time, he owned a 99% interest in the James Heller Family LLC (JHF). His son and daughter each held a 0.5% interest in JHF, the only asset of which was an account (JHF Madoff account) with Bernard L. Madoff Investment Securities LLC (Madoff Securities). Between March 4 and Nov. 28,2008, the manager of JHF withdrew $11,500,000 from the JHF Madoff account and distributed it according to JHF s ownership interests. The estate received $11,385,000 of the amount distributed, which it used to pay its taxes and administrative expenses.

In December 2008, Bernie Madoff was arrested and charged with securities fraud for perpetrating a multibillion-dollar Ponzi scheme through Madoff Securities. In March 2009, Madoff admitted that Madoff Securities was a massive Ponzi scheme and pleaded guilty to various federal crimes (for which Madoff eventually was sentenced to 150 years in prison). Because of the Ponzi scheme, JHF's interest in the JHF Madoff account and the estate's interest in JHF became worthless.

The estate in April 2009 timely filed an estate tax return, on which it reported a $26,296,807 gross estate, which included Heller's 99% interest in JHF (i.e., $16,560,990). The estate also claimed a $5,175,990 theft loss deduction under Sec. 2054 relating to the Ponzi scheme, the difference between the value of the estate's interest in JHF reported on the estate tax return and the estate's share of the amounts withdrawn from the JHF Madoff account. The 1RS issued the estate a notice of deficiency in which respondent determined that the estate was not entitled to the $5,175,990 Sec. 2054 theft loss deduction because the estate did not incur a theft loss during its settlement.

The estate timely filed a petition with the Tax Court challenging the IRS's determination, and subsequently the estate moved for summary judgment, arguing that as a matter of law it was entitled to the deduction.

The Tax Court's Decision

The Tax Court held...