IRS giving relief to some Madoff investors

Victims of New York financier-swindler Bernard Madoff will get tax relief from Uncle Sam, but not as much as some had hoped.

The Internal Revenue Service issued guidelines Tuesday that could help many of the 4,800 victims of Madoff’s $65-billion investment fraud recoup some of their losses by seeking reimbursement of up to five years of past tax payments.

“Beyond the toll in human suffering -- as entire life savings and retirements appear to have been wiped out -- the Madoff case raises numerous tax and pension implications for the victims,” IRS Commissioner Doug Shulman told the Senate Finance Committee.

Under the guidelines, money that disappeared in Madoff’s Ponzi scheme will be classified as a theft loss, potentially providing victims with a much bigger tax deduction than if it were classified as a regular investment -- or capital -- loss.

Madoff pleaded guilty Thursday in federal court in Manhattan to 11 securities-related fraud counts. As investors in the courtroom applauded, Madoff was led to jail to await a June 16 sentencing hearing.

On Tuesday, the U.S. government broadened its claims on assets held by Madoff and his wife, Ruth. In court papers filed in New York late Tuesday, the government laid claim to $31.5 million in loans from the Madoffs to their sons, a series of limited partnerships, $2.6 million in jewelry and “approximately 35 sets of watches and cuff links.”

The government also filed a motion arguing that Madoff should remain in jail while awaiting sentencing because he is a risk to flee to avoid facing a sentence that could keep him behind bars for the rest of his life.

The IRS guidance allows victims to claim as losses money they invested with Madoff over the last five years and never got back, as well as “phantom profits” they paid taxes on during those years -- that is, profits that appeared on their annual account statements but didn’t actually exist and were never paid to the investor.

The IRS rules also allow the losses to be claimed in the year in which the fraud was exposed. Because the Madoff scandal came to light in December, victims can include their claims on 2008 tax returns.

Although the guidelines provide some relief, some victims said they didn’t go far enough. Legislation has been proposed that would allow Madoff investors to claim losses going back a dozen years or more.

“At best it’s a modest concession and not as helpful as people need,” said Northridge resident Elliott Kaye, 61, who began investing with Madoff in 1992 and lost almost $1.3 million.

“If they had carried it back to allow you to amend your returns back to 1992, that would be a different story.”

The guidelines probably won’t affect losses by charities and retirement accounts, which are tax-exempt. And it’s not clear whether California will provide special treatment for Madoff victims on their state taxes.

Investors who file a claim with the IRS must first deduct any settlement money received from the Securities Investor Protection Corp. -- which will cover up to $500,000 in losses per Madoff account -- or from private insurance policies.

After that, investors can claim a deduction for 95% of their remaining losses for the five-year period.

Santa Monica attorney Stanley H. Epstein, who has been following the case, described the IRS guidelines “as a public relations stunt.” Epstein said the government might ultimately recover substantial amounts of money from people who actually made profits investing with Madoff over the years. As a result, he said, some victims may recover “far more than the 5% assumed by the IRS.”

If victims decide to sue any third parties in the case, such as investment advisors who may have steered them to Madoff, they can claim only 75% of their losses on the expectation that they may recover some of their money through court proceedings.

Forms for filing a claim for losses dating to 2004 are available on the IRS website, www.irs.gov.

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martin.zimmerman@latimes.com

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Carol J. Williams contributed to this report.