In the case of Giambrone et al v. Commissioner, TC Memo 2020-145[1] the Tax Court ruled that a taxpayer must strictly follow an IRS revenue procedure granting a more favorable tax treatment than normally would be available if the taxpayer wishes to take advantage of the procedure. 

The case involved what is often referred to as the “Madoff ruling” found at Revenue Procedure 2009-20.  The revenue procedure grants taxpayers relief from the normal provisions for claiming a theft loss from criminally fraudulent investment arrangements, such as Ponzi schemes.  The ruling was issued following the confession of Bernie Madoff to having run one of the largest Ponzi schemes ever.

The procedure allowed taxpayers to claim theft losses from such schemes under a simplified reporting method.  If a taxpayer is not pursuing a potential third-party recovery, the taxpayer may claim as a loss 95% of the qualified investment.  In this case, the key issue was when that deduction had to be claimed under the revenue procedure.

The loss is to be claimed in the discovery year as defined in the Revenue Procedure.[2]  The discovery year is defined as:

.04 Discovery year. A qualified investor’s discovery year is the taxable year of the investor in which the indictment, information, or complaint described in section 4.02 of this revenue procedure is filed.[3]

The indictment, information or complaint relates to the lead figure(s) in the fraudulent scheme.[4]  In this case the lead figure was Mr. Farkas, and the action against him was described as follows in the opinion:

On June 15, 2010, a Federal grand jury returned an indictment against Mr. Farkas charging him with conspiracy and bank, wire, and securities fraud. According to the indictment Mr. Farkas had devised a scheme to misappropriate over $1 billion in funds from various financial institutions, including TBW, the FHLMC, the Government National Mortgage Association, and the Troubled Asset Relief Program. A jury convicted Mr. Farkas on April 19, 2011, and he later was sentenced to 30 years in prison.[5]

The Giambrones were investors that were a victim of the fraudulent scheme.  However, as the opinion notes, they did not claim a loss under Revenue Procedure 2009-20 until the filing of their 2012 income tax return, despite Mr. Farkas being indicted two years earlier:

The Giambrones claimed theft loss deductions of 95% of the value of their investments in Platinum on their 2012 Federal income tax returns. The Giambrones premised their claimed deductions on Rev. Proc. 2009-20, sec. 1, 2009-14 I.R.B. at 749, which provides “an optional safe harbor treatment for taxpayers that experienced losses in certain investment arrangements discovered to be criminally fraudulent.”[6]

The IRS challenged the deduction, noting that the Revenue Procedure was not available to be used on the 2012 return—if they were going to make use of that safe harbor, the taxpayers were required to do so on their 2010 return, as that was the year Mr. Farkas was indicted.

The taxpayers argued that limiting the discovery year to the single year the lead figure is indicted is not compatible with IRC §165(e) and Reg. §1.165-1(d)(3), and that their treatment of 2012 as that year is compatible with that broader rule.[7]

The Tax Court begins its analysis by noting that a Revenue Procedure is not binding on the Tax Court and, thus, “even if the Giambrones were to establish that the IRS had erred in its application of Rev. Proc. 2009-20, supra, we would not be required to conclude that they are entitled to the claimed theft loss deductions.”[8]

The Court notes that the taxpayers concede they did not request safe harbor treatment on their 2010 income tax returns.  The Court then notes that the taxpayers are in error when they assert the safe harbor must include the broader view of the discovery year found in the IRC and regulations:

The Giambrones are laboring under a fundamental misconception: Rev. Proc. 2009-20, supra, is not required to comport with the terms of section 165 (or the accompanying regulation). It is an exercise of administrative discretion on the part of the IRS, offering beneficial treatment for categories of theft losses meeting certain well-defined conditions. The Giambrones cannot gain the benefit of it without adhering to its conditions the IRS imposed. See, e.g., Beech Trucking Co. v. Commissioner, 118 T.C. 428, 444 (2002)[9]

In a footnote, the Court expands on the analysis.  Since the IRS has granted a benefit not otherwise available under the IRC, the only issue for dispute is if the IRS fails to follow the terms of the relief itself:

“We have recognized * * * that an abuse of discretion can occur where the Commissioner fails to observe self-imposed limits upon the exercise of his discretion, provided he has invited reliance upon such limitations.” Capitol Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C. 204, 217 (1991). Here, the IRS stayed within the bounds set forth in Rev. Proc. 2009-20, supra, when disallowing the Giambrones’ belated safe harbor requests.[10]

The taxpayers may avail themselves of the provisions of the law and regulations, presuming that 2012 would be a proper discovery year under those rules.  But the taxpayers would also face other limitations on claiming a loss in those cases.  As Revenue Procedure 2002-90 noted as a justification for its safe harbor when released:

.03 The Service and Treasury Department recognize that whether and when investors meet the requirements for claiming a theft loss for an investment in a Ponzi scheme are highly factual determinations that often cannot be made by taxpayers with certainty in the year the loss is discovered.

.04 In view of the number of investment arrangements recently discovered to be fraudulent and the extent of the potential losses, this revenue procedure provides an optional safe harbor under which qualified investors (as defined in § 4.03 of this revenue procedure) may treat a loss as a theft loss deduction when certain conditions are met. This treatment provides qualified investors with a uniform manner for determining their theft losses. In addition, this treatment avoids potentially difficult problems of proof in determining how much income reported in prior years was fictitious or a return of capital, and alleviates compliance and administrative burdens on both taxpayers and the Service.[11]

That is, the taxpayers could make use of the broader view of the discovery year in the law and regulations—but if they do so, they have to take on the burdens of dealing with all of the requirements of applying the law that the safe harbor mitigates.

In the view of the Court, the IRS is not forced to allow taxpayers to, effectively, use the parts of the safe harbor that are favorable to them and ignore those portions that present problems in their case—it’s an all or nothing option to make use of the safe harbor.

[1] Giambrone et al v. Commissioner, TC Memo 2020-145, October 19, 2020, https://www.ustaxcourt.gov/UstcInOp2/OpinionViewer.aspx?ID=12344 (retrieved October 20, 2020)

[2] Revenue Procedure 2009-20, Section 5.01

[3] Revenue Procedure 2009-20, Section 4.04

[4] Revenue Procedure 2009-20, Section 4.02

[5] Giambrone et al v. Commissioner, TC Memo 2020-145, p. 5

[6] Giambrone et al v. Commissioner, TC Memo 2020-145, pp. 5-6

[7] Giambrone et al v. Commissioner, TC Memo 2020-145, p. 11

[8] Giambrone et al v. Commissioner, TC Memo 2020-145, p. 10

[9] Giambrone et al v. Commissioner, TC Memo 2020-145, p. 12

[10] Giambrone et al v. Commissioner, TC Memo 2020-145, p. 12, Footnote 7

[11] Revenue Procedure 2009-20, Section 2.03-2.04