The Ponzi Clawback And The Value Of The Mitigation Procedure
A Ponzi Scheme Clawback payment of profits is typical in many Ponzi Schemes. Ponzi Scheme Trustees appointed to achieve fairness among defrauded investors have successfully recovered billions of dollars from innocent Ponzi Scheme investors who profited from the Scheme even though there were indeed no real profits at all in a Ponzi Scheme.
Everyone but the promoter eventually loses money. The promoter usually goes to jail and losses money.
What is a “Clawback”? Funds made by those investors lucky enough to have escaped the Ponzi fraud, and who took their profits early in the scheme, remain profitable until the Trustee “CLAWED BACK” their false profits.
A Ponzi Scheme “Clawback” payment is accomplished when a Trustee obtains refunds from those who benefitted from the early “profits distributions” by the Ponzi Scheme.
A Ponzi Clawback of Ponzi Scheme profits from the innocent investor who first benefitted from the Scheme can receive a unique treatment from a tax standpoint. This is because of a special Internal Revenue Code Section that applies to Ponzi Scheme Clawback Payment and Ponzi Scheme Clawback tax treatment.
There is a significant difference between refunds from a tax credit and a tax deduction. The refunds from a tax credit can amount to significant more dollars. The right to use Internal Revenue Code Section 1341 (the “Mitigation Section”), and seek a tax credit cannot be overlooked by Clawback tax victims.
The Mitigation Section
The Mitigation Section of the Internal Revenue Code is a unique Internal Revenue Code Section that permits a taxpayer to reopen a closed statute of limitations to claim a refund when the taxpayer has withdrawn profits from the fraudulent Ponzi scheme and later found out these were false profits that must be repaid to the Ponzi Scheme victims who lost money. Code Section 1341.
The Mitigation Section permits a taxpayer, who had withdrawn profits from a Ponzi Scheme and paid tax on those profits when the taxpayer was in a high tax bracket, to go back in time even though the statute of limitations has closed on the taxable year in which the false profits were made, and the taxpayer can claim a refund on the taxes paid in that year.
The taxpayer who must pay back the false profits can choose to take advantage of the right to reopen the previously closed statute of limitations and receive the refunds based on the prior years taxes if higher taxes were paid on those profits; instead of merely receiving a current deduction in the year that the business profits are repaid.
The Trump Tax Cut & Jobs Act eliminated the loss carryback rules, it did not eliminate the rules under the Mitigation Section.1 Taxpayers who are forced to repay false profits may still reduce the income falsely reported in the prior years, if that provides a larger tax refund than the refund that would be available if the “clawed back” funds were only allowed to be deducted in the year of payment.
This tax benefit cannot be overlooked.
Starting in 2018, it is critical to compare the amount of refunds on a Clawback of profits with the value of deducting the Clawback amount in the year it is paid back.
However, the Mitigation Section only applies to reopen the statute of limitations and treat the false profits as if they were never earned when there is a Clawback of profits.
The Treatment of a Clawback of Invested Principal (and not a Profits) Amount
In many cases a Trustee can claim recovery (Clawback) of an investor’s principal amount invested in the Ponzi Scheme when these principal amounts were paid back to the investor shortly before the collapse of a Ponzi fraud. In this case, the clawed back amounts of principal will not be able to reopen the closed years and the Clawback amounts of principal will be treated similar to the regular losses suffered by Ponzi Scheme victims.
- In a separate section we discuss the deduction of Ponzi Scheme Theft Losses for those taxpayers who cannot benefit from the “Mitigation Section”. See also PONZI SCHEME LOSSES – HAS THE TRUMP TAX BILL MADE BUSINESS THEFT LOSS DEDUCTIONS LESS VALUABLE?