In the interviews with Bernie Madoff’s victims an interesting question came up which I thought I’d put on the floor. Let’s say you were one of Madoff’s victims, that Madoff reported earnings to you, and you paid taxes on those earnings. If you re-file a corrected return, will you receive a refund of the amount of tax that you paid on the fraudulent earnings?
That’s a complex tax law question but my tentative answer is… maybe.
I realize it’s a non-trivial question. That’s why I found it interesting.
Let me understand the sequence here: These investors owned shares of a mutual fund that was required by law to distribute capital gains to its investors periodically. The investors paid taxes on these gains. It seems like there are two options:
1. These were real gains, the investor could have cashed out at any time and would have received the benefit of the reported gains. The losses arise from the accepted risk of not getting out earlier.
2. The gains were made-up. These were fictitous transactions, used to fraudulently report profits.
I sort of favor 1, but I may not know enough about the transactions. But I’m stuck by my understanding that these were real gains in the sense that the investor could have cashed-out and received the values being reported. 2. also seems to be difficult if the gains were partly made-up and partly real, and certainly some of the losses in this market would have occurred irregardless.
One of the related issues is that people who cashed-out early may have their returns subject to claw-back lawsuits from those who suffered losses. That, plus claims on Madoff, his wife, his bankruptcy estate and any brokerage insurance, means that the investors will get some additional return on their investment, there is just no way to value it outside of litigation. Loads of valuation issues make this impractical.
It is an interesting question.
I think the easy piece is: you had an initial basis, you now have zero, you get that capital loss.
The hard part, as you point out, what about the reported divs and cap gains along the way? I have a sneaking suspicion the IRS will say: who says they weren’t real……….. at the time of reporting? Your redress is with the fund manager…………good luck and thanks for the dough.
PD – don’t you think people sueing early withdrawers will have to prove inside knowledge, something similar in concept of preference payments in bankruptcy?
Drew, just from reading some legal commentary on the web a few months ago, as I recall once a court determines that this was a Ponzi scheme, then the presumption is that the participants should equitably share in the losses unless an investor proves absolute innocence. What I had read suggested this was an unpredictable area. The statute of limitations would protect the oldest distributions though.
It will be interesting to watch unfold. As I see it, there is innocence from criminal liability; innocence in the eyes of G*d and innocence in the context of regulatory laws intended to equitably distribute losses. I’m not sure these investors are “innocent” in all of these senses.
“I’m not sure these investors are “innocent†in all of these senses.”
What? Straight line yearly 15% returns aren’t credible?
;->
That’s what I was thinking of when I wrote:
in Great Expectations.