Here are the questions I posed to the receiver and below is
the reply I got. If you or someone else knows about any
code sections which talk about the taxation of embezzlement
of funds and their subsequent repayment, please let me know.

Hi Mr. xxxx, I was hoping you could clarify some tax issues
related to this case for someone that I am preparing taxes.
Namely, I would like to know the following:

1) In prior years, if "windfall" profits were reported to
the IRS and taxes paid, is this the correct treatment even
though the SEC may be wanting to collect these funds from
the "investor."

2) If the answer to number one is no, it should not have
been reported to the IRS, in your experience with these
cases, does the traditional 3 year statute apply for
collecting a refund or does the special 7 year statute apply
for bad debt/worthless stock? Or some other statute of
limitations?

3) If the answer to number one is yes, it should have been
reported to the IRS, but money is later collected from the
investor, is there a loss that can be reported for the
current tax year for "forfeiture" of assets to the SEC
besides the losses claimed due to the theft by Correll in
2005? And

4) Regarding a theft loss for 2005 under IRC Section 165, is
this a tenable position with the IRS or do they have a
history of challenging this deduction in tax court as I have
read in other cases?

Let me know if I've worded this poorly and you don't
understand what I'm asking. I appreciate any advice you can
provide. Thank you.

Response:

Because each individual investor situation is different, we
have posted on our web site some information that investors
are asked to share with their tax professionals which may
help them determine the treatment of their situation for tax
purposes. That link is
http://www.haysconsulting.net/correl...ifications.pdf

As far as your first question, I have not researched this
and thus can offer no conclusions. In your research, perhaps
you might want to investigate the similarities between that
situation and the taxation of embezzlement proceeds and
their subsequent repayment. I'm sorry I can be of no
further assistance.

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L K Williams <lanny[at]loxinfo.co.th> wrote:

- quote -

The generalish case: somebody receives money that he thinks
is income; however, in a future year he finds out it wasn't
his, and is required to return it. Which year's tax return
does it go on? (Does it matter if the year he received it
during is closed? What if it gets returned before he files
for the year in which he received it?)

Does the same rule apply to payments clawed back by
bankruptcy courts?

Seth

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sethb[at]panix.com (Seth Breidbart) wrote:
- quote -

I hadn't considered that possibility. I'm not even sure
that he would be required to repay. If he did, though, I
would think he has a deduction in the year of repayment and
not a reason to amend earlier returns.

Again, I've never had a client in this situation, so I
haven't actually researched the situation.

Lanny K. Williams, CPA
Nawarat, Williams & Co., Ltd.
Income Tax Services for Expatriate Americans

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L K Williams <lanny[at]loxinfo.co.th> wrote:

- quote -

Wouldn't the SEC still make him give it back (if they found
him)?

Seth

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"Stuart A. Bronstein" <spamtrap[at]lexregia.com> wrote:
- quote -

I'll admit I've never had a client in this situation and
I've not done the research but I still think it is
reportable as interest each year.

See my remark about withdrawing before the scheme collapsed.
Wouldn't the excess of proceeds over basis be interest
income?

Lanny K. Williams, CPA
Nawarat, Williams & Co., Ltd.
Income Tax Services for Expatriate Americans

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Thanks for the reply. I was wondering the same thing as
illegal profits are still profits. This is how they got Al
Capone after all. This is definitely a new one on me
however so I want to explore every avenue.

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L K Williams <lanny[at]loxinfo.co.th> wrote:
- quote -

The question in my mind is, was it really interest? In a
polzi scheme they tell you it's interest but it's really a
return of principal - yours or someone else's.

Stu

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allace_cpa[at]msn.com wrote:

- quote -

I don't believe that amended returns are appropriate. At
the time, the "interest" credited was reportable income.
The subsequent failure of the scheme does not change that.
In theory, at least, your client could have withdrawn from
the scheme at some point and would not have incurred any
loss. The loss did not occur over time but at the time the
SEC terminated the operation.

Lanny K. Williams, CPA
Nawarat, Williams & Co., Ltd.
Income Tax Services for Expatriate Americans

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Forgot to add that it works out that the amount of "profits"
made happens to be equal to the amount of taxes paid in
prior years. So, with the refunds, this would be a wash.
Was also wondering if the statute of limits for a refund
would be the regular 3 years or the special 7 years for
worthless stock / bad debt. Or would it there be something
that could be claimed in the year the "profit" was returned
to the SEC receiver?

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I have someone who was recently involved in a Ponzi scheme
that was shut down by the SEC. This person started
investing money in 2002 and immediately began receiving
return checks equal to 9% a month in "profits." In 2002,
this person reported the income on their return and paid the
tax. Same thing happened in 2003 and 2004. However, in
2003, this person also pulled out part of their original
investment. In 2005, they lost some money but, overall, made
a profit. I'm curious as to how other tax preparers would
handle this situation. My first inclination is to file for
refunds for 2002, 2003 and 2004 as these were ficticious
profits and send this money to the receiver established by
the SEC to pursue these funds. My other thought is to file
a theft loss under section 165 for 2005 and let the Receiver
worry about the taxes if they plan on trying to collect any
of these funds. Any thoughts here?

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