Ponzi schemes are unfortunately still a threat to investors. In 2024 alone, authorities uncovered 60 alleged Ponzi schemes involving $3.25 billion in investor funds—the highest amount since the Great Recession. If you’ve fallen victim to a Ponzi scheme, there’s some good news on the tax front: the IRS tax-favored Ponzi scheme loss deduction rules remain in place, thanks to the Tax Cuts and Jobs Act (TCJA).
Let’s break down how this works and how it can help you.
What Is a Ponzi Scheme?
A Ponzi scheme is an investment fraud where the schemer uses new investors’ money to pay returns to earlier investors, creating the illusion of a profitable investment. Unfortunately, many people fall victim to these schemes, and the financial consequences can be devastating.
The IRS Safe Harbor: Good News for Victims
The IRS provides a tax relief safe harbor to help victims of Ponzi schemes recover some of their losses. Here’s how it works:
- Ponzi Scheme Loss as a Theft Loss
The IRS allows victims of Ponzi schemes to deduct the loss as a theft loss. This is significant because theft losses are not usually deductible under the Tax Cuts and Jobs Act for other types of personal thefts. - When the Loss Is Deductible
You can deduct the loss in the year the Ponzi scheme is discovered, which is defined as when:
- A lead figure is charged with fraud, embezzlement, or a similar crime;
- The person is subject to a state or federal criminal complaint and either admits guilt or has assets frozen by a court-appointed trustee;
- Or, if the person behind the scheme dies, and the fraudulent arrangement is frozen by a trustee or receiver (no criminal charges required in this case).
- A lead figure is charged with fraud, embezzlement, or a similar crime;
- The Safe Harbor Calculation
The IRS offers a safe-harbor formula to compute the loss amount. Depending on the facts of your case, you can deduct 95% or 75% of the loss in the year you file for the safe harbor.
How the Deduction Works for Individuals and Businesses
If you’ve been the victim of a Ponzi scheme, the loss is treated as a theft loss under the tax code, and it is fully deductible as an itemized deduction (not subject to the $3,000 capital loss limit). For businesses, this theft loss is treated as a business casualty loss, which is also fully deductible.
Subsequent Years and Recoveries
After filing for the safe harbor and deducting the loss, you may receive additional income related to your recovery in future years. If this happens, you’ll need to report it as taxable income in the year you recover the funds, in accordance with the tax benefit rule.
If the amount of your loss increases because you recover less than the original amount you claimed, you can deduct the additional loss in the year it’s identified with reasonable certainty.
The Ponzi Scheme Loss and NOL (Net Operating Loss)
If your Ponzi scheme loss results in a Net Operating Loss (NOL), you can carry that loss back to earlier years (up to five years) or carry it forward. For example, if you have a 2020 Ponzi scheme loss, you can carry it back to your 2015 tax year, potentially getting a refund for past taxes.
Planning Tips
If you’ve been affected by a Ponzi scheme, it’s important to address this issue promptly. We can help you calculate the loss, determine the best way to file the deduction, and maximize the benefits of the Ponzi scheme loss.