Tax relief for small Madoff investors eyed

WASHINGTON — Tax relief for thousands of small, indirect investors in Bernard Madoff’s swindle and other fraudulent schemes appears close to Senate adoption as part of a broader bill to extend unemployment benefits.

An amendment by Sen. Charles Schumer, D-N.Y., puts the indirect Madoff investors — who channeled their money through “feeder funds” run by middlemen — on the same tax footing for their “phantom” profits as wealthy investors who were required to put up millions to invest directly. The people who invested through feeder funds often weren’t aware that their money went to Madoff.

The unemployment extension bill, which provides up to 14 additional weeks of insurance benefits to out-of-work people whose benefits are running out, was expected to pass the Senate late Tuesday or Wednesday.

The Internal Revenue Service issued guidelines in March that allowed tax relief and refunds for victims of Ponzi schemes like Madoff’s, in which investors are paid with other investors’ money rather than actual profits on their investment. But investors in a business with more than $15 million in assets — a level exceeded by the Madoff feeder funds — were not eligible for the tax break.

The ranks of victims who lost billions investing with the disgraced financier include Hollywood celebrities and scores of famous names in business and sports — as well as big hedge funds, international banks and charities. Thousands of ordinary people also were defrauded in what could be the biggest Ponzi scheme ever.

There is no similar measure yet before the House.

Madoff investors should have paid taxes on earnings from their “feeder fund” investments through the years — the scheme stretched from the early 1990s to Madoff’s arrest in December. Given that some of those were fictitious profits, investors say they should be entitled to refunds of those taxes.

Investors in some of these cases are entitled to a “theft-loss” deduction, not subject to the limits on normal investment losses, according to the IRS guidelines. Investors can deduct 95 percent of their losses immediately. If they are unable to recover the remaining 5 percent, they can claim those deductions in subsequent years.

If deductions claimed in the current year result in a “net operating loss” for taxpayers, meaning they would owe no taxes, they can apply excess deductions to prior years, getting a refund for taxes already paid. They can also use the deductions in future years to lower their tax burden.

Madoff, a former Nasdaq stock market chairman, pleaded guilty in March to charges that his secretive investment-adviser operation was a multibillion-dollar Ponzi scheme that destroyed thousands of people’s life savings and wrecked charities. He is serving a 150-year sentence in federal prison in North Carolina.

On Tuesday, Madoff’s longtime auditor pleaded guilty to securities fraud charges, saying he failed to do his job to verify financial records but didn’t know that Madoff was running the massive scheme.