IRS tells investors feeling robbed doesn't count for deductions
BY HARRIET JOHNSON BRACKEY
Knight Ridder Newspapers
(KRT) - Investors who feel they've been robbed by Enron and WorldCom and other corporations caught in fraud and accounting scandals won't get any sympathy - or tax deductions - from the Internal Revenue Service.Your money was not stolen if you lost it in an investment bought on a public stock exchange, the Treasury Department warns. Some promoters have been trying to make that claim, to get bigger and faster tax deductions for investors. But the IRS said it will disallow any such deductions it finds on returns.
In the rush toward April 15, the Treasury in two releases this week put out warnings against what it said were media reports and anecdotes concerning "frivolous" deductions.
"We want to make sure people aren't mislead by theories," Acting Assistant Treasury Secretary for Tax Policy Greg Jenner told The Herald Friday.
Another idea making the rounds that Jenner said won't fly: Taxpayers who exercise stock options can avoid income tax or the alternative minimum tax. "Taxpayers should be very cautious about claiming refunds on this basis," he said.
As for Enron and WorldCom, "It wasn't the companies that robbed you of the money, it was the market," said Martin Nissenbaum, national director of personal income tax planning at Ernst & Young.
What's not clear is what will happen to investors who have been scammed, by pyramid or Ponzi schemes or South Florida's notorious boiler-room operations. Those sorts of issues, attorneys say, have to be well-documented and may land up in tax court for a final decision.
A tax consulting firm, J.K. Harris, is promoting the idea that these losses can be treated as theft under Section 165 of the tax code. The firm's Web site: www.165services.com.
The firm takes a fee, based on the loss, for its services, which include gathering background material for the taxpayer and agreeing to represent the taxpayer in case of an IRS audit.
Richard Kess, head of client services for J.K. Harris in Tampa, Fla., says his company has helped 500 injured taxpayers seek $25 million to $30 million in such deductions in the last 2 1/2 years.
Beverly Joyce Barea is one. She said Friday that she's waiting for a $16,000 tax refund. She lost more than $200,000 in an investment scam about four years ago, had to go back to teaching to make ends meet and during it all, survived a bout with cancer in her thyroid.
"I never thought I'd get anything after what happened," said the 69-year-old widow who lives in the central Florida town of Avon Park.
She still may not.
For scammed investors, Jenner said only there's only a possibility of a legitimate deduction. "You can never say never, but it seems very, very unlikely," he said.
Martin Press, an attorney at Gunster, Yoakley & Stewart in Fort Lauderdale, Fla., says he's handled cases in which the investment advisor said he was going to buy securities or put money into tax shelters, but never did.
Press calls that embezzlement and the IRS has agreed, he said. "Let me tell you what these taxpayers have to prove: that the investment never took place," he said.
What's the reason people want to call investment losses a theft?
It's a better deal in terms of tax breaks.
Taxpayers can deduct all of a theft loss on investment property in one year against ordinary income tax, which can run up at rates up to 35 percent.
If instead the taxpayer deducted investment losses, there are annual limits. First, the amount of capital losses is used to offset any capital gains, such as profits on the sale of other stocks. Second, the tax deduction is worth less, because the tax rate on capital gains is a maximum of 15 percent.
And, if the taxpayer has more losses than gains, the extra losses can only be used up at a rate of $3,000 a year to offset ordinary income taxes. If it takes years to use up the extra amount, that's the way it goes, according to IRS rules.
State law has to define something as a theft in order for taxpayers to deduct it from their federal income taxes. Nissenbaum notes that the legal idea of theft includes a direct connection between the robber and the one whose property is lost.
"Whoever pleaded guilty at Enron would have to pocket your money directly," he said. "Unless state law starts to treat that as theft from you, you have to say the market ran away with it."
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