Service intends to disallow theft loss deductions for declining stock prices.

• Author: O'Driscoll, David

The Service has advised it intends to disallow theft losses for declines in stock value due to the disclosure of accounting fraud and other misconduct by a corporation's officers and directors; also, it may impose penalties under Sec. 6662.

Losses in General

Sec. 165(a) allows a deduction for any loss sustained during the tax year not compensated for by insurance or otherwise. Under Regs. Sec. 1.165-1(b), generally, the loss must be evidenced by a closed and completed transaction, fixed by an identifiable event(s) and actually sustained during the tax year.

According to Regs. Sec. 1.165-4(a), no deduction is allowed under Sec. 165(a) solely on account of a decline in stock value when the decline is due to a market fluctuation or to another similar cause. However, a deduction is allowed under Sec. 165(a) if the stock is worthless and has no recognizable value. A decline in stock value is not allowed as a deduction until the tax year in which the loss is actually sustained as a result of a sale or exchange or the stock becoming wholly worthless. Under Regs. Sec. 1.165-5 (c), a loss for wholly worthless stock may be deducted under Sec. 165(a), but is subject to capital loss limits under Secs. 1211 and 1212.

Theft Losses

Individuals may deduct theft losses under Sec. 165(c)(3). Whether a loss is a theft loss is determined by examining the law of the state where the alleged theft occurred (Edwards, 232 F2d 107 (5th Cir. 1956); Viehweg, 90 TC 1248 (1988)). Thus, to claim a theft loss, a taxpayer must prove that the "loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal...