Emotions Aside, Stock Drops Fail to Equal Theft
It’s OK for investors to feel ripped off -- just as long as they don’t claim they were robbed.
Or so say federal tax officials, who are trying to stem a recent trend of shareholders claiming theft losses when the value of their stock takes a hit.
The parade of corporate financial scandals has been a catalyst for these claims, as some shareholders whose holdings have been vaporized by disclosures of corporate misdeeds are trying to write off these losses as thefts, the Internal Revenue Service says.
The IRS says that these declines in value are capital losses and that they may not be characterized as thefts.
The agency doesn’t have statistics on how many investors are attempting to claim theft. But IRS officials say Internet chatter and a sample of tax returns have them concerned enough to put out a warning that such claims will be disallowed -- and that taxpayers who improperly claim them could face penalties.
“Shareholders who purchased stock of some high- profile corporations on the open market have suffered declines in the value of their investment as a result of misconduct by corporate executives,” acknowledged Greg Jenner, acting Treasury assistant secretary for tax policy. “However, these losses are not theft losses under state law and therefore are not deductible theft losses for federal income tax purposes.”
It isn’t surprising that some stockholders would want to characterize their market losses as thefts. A theft loss would give investors a significantly better tax bang for their lost buck than a capital loss.
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A Tax Advantage
Tax laws require that capital losses be used first to offset capital gains, which are taxed at a maximum rate of 15%. Theft losses, meanwhile, are deducted from ordinary income that can be taxed at rates as high as 35%.
Despite the tax rules, that 20-percentage point difference can be tempting to a high-bracket taxpayer, said Matthew Richardson, tax partner at Los Angeles law firm Sheppard, Mullin, Richter & Hampton.
It’s not just investors who are calling some company executives thieves. Government charges against corporate in- siders suspected of accounting fraud and misappropriation of company funds are rife:
* Jamie Olis, vice president of finance at onetime energy giant Dynegy Inc., was sentenced to 24 years in prison March 25 for his role in falsifying financial statements.
* Adelphia Communications Corp. founder and former Chairman John Rigas and his two sons are being tried on charges of conspiracy and fraud.
* Global Crossing Ltd. founder Gary Winnick and other former executives of the telecommunications company recently agreed to pay $324 million to settle investor charges of securities fraud.
* L. Dennis Kozlowski, Tyco International Ltd.’s former chief executive, and Mark Swartz, the former chief financial officer, were tried on allegations of looting the company. The case ended in a mistrial Friday.
Still, as compelling as the case for theft may be, the problem for investors is that the firm suffered the theft, not the individual owners, said A.J. Cook, partner at Memphis, Tenn., law firm Pietrangelo & Cook.
“The corporation is a separate legal entity,” he said. “The stockholder has the stock before the theft; they will have the stock after the theft. The value of the stock is simply going down because of something that happened to the corporation.”
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In Rare Cases It Is Theft
Is there ever a time when an investment loss could be considered a theft? Yes, experts note. But those instances are rare.
First, an investor in a publicly traded stock can never claim a theft loss for a decline in the share’s market value. The presumption is that no one is trying to defraud you when you buy shares on the open market, Richardson said.
However, an investment that is not publicly traded and was sold directly by the thief to the individual might qualify, he said. People snared in Ponzi schemes, for instance, could have a compelling case to claim theft losses.
The deductible loss cannot exceed the taxpayer’s “basis,” the amount actually invested, however. Someone who invested $10,000 and continued to roll over fictional gains as they were maturing -- as is the claim with many Ponzi schemes -- would be able to deduct the $10,000, not the $100,000 the investor lost on paper.
What if the investor paid tax on those phantom gains as they went along? Theoretically, the person should go back and amend all the relevant returns to eliminate the fabricated income, said Martin Nissenbaum, partner at accounting firm Ernst & Young in New York. But, practically speaking, if the income was claimed on returns more than 3 years old, the taxpayer could simply increase the basis by the amount of “gain” that he or she had paid tax on.
One other note about theft losses: There are two types -- personal losses of things such as a car or bike, and investment thefts.
If personal property was stolen, the investor’s deductible loss is severely limited. The loss is deductible only to the degree that it exceeds 10% of the taxpayer’s adjusted gross income plus $100. In other words, a taxpayer earning $50,000 could deduct only personal theft losses that exceeded $5,100.
If investment property (property purchased with the intention that it would generate income) is stolen, the loss is fully deductible in the year that the loss is discovered.
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Kathy M. Kristof welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com.
