Theft Losses and Legal Fees

[Howco]

Taxpayer brought a suit against a business partner for fraud/embezzlement. Taxpayer won judicial settlement for an award that is a fraction of the amount that was embezzled.

Can the balance of the unrecovered loss be deducted as a theft loss? I think it can...see Goeller, US Court of Federal Claims, March 2013.

Are the taxpayer's attorney fees deductible? I don't believe so, as they were paid for a property claim that is non-taxable. However, I wasn't sure if they could be added to the ultimate theft loss?

The taxpayer now holds a note (without interest) for the settlement that was awarded. If this note doesn't get repaid, would it be appropriate to deduct the unrecovered balance as a capital loss, subject to $3,000/year loss limitation?

Thanks for your feedback.

[ChEAr$]

Just who is the taxpayer? Is it a corporation or an individual?

What acvounting method does taxpayer use? cash or accrual? Was the amount of embezzlement recovered already not included in income previously? Those questions just for starters.

[ATSMAN]

Excellent points raised by Harlan. Please read the instructions to form 4684 and 4797 carefully.

I had a situation few years back where by client suffered a massive hear attack and was out for 6 months. His wife and a longtime employee ran the repair business for that period and upon his return he discovered that the employee had stolen cash and parts etc.

He contacted me and his attorney and a police report was made (key factor), inventory taken and appropriate adjustments and casualty/theft loss taken.

There was no insurance involved. The loss was over 80K.

[Howco]

Taxpayer is an individual. Cash basis. Funds were loaned to a business. No money has been recovered/included in income. The taxpayer won a settlement in court, on the basis that the money loaned to the business was taken by fraud/intent to deceive, etc. Lots of language in the settlement that would support the argument for theft.

The amount of the settlement awarded is evidenced by a note payable to the taxpayer. The award is less than the amount loaned/'stolen'.

Reaching out for feedback to see if the difference between the amount loaned and the amount awarded can be treated as a theft loss. Taxpayer has significant supporting documentation and eager to pursue this path. Goeller case would seem to support a theft loss in a business embezzlement situation.

[Burke]

Can he actually document the total amount of the loss, i.e, the loaned funds over and above the amount awarded in court? If so, why was the amount reduced? Was there a promissory note or other legal document at the time of the original loan? With interest? Without proper documentation of this sort, IMO, the amount to be written off as a bad debt would be the amount of the current note awarded by the court. And only after that note is determined to be uncollectible. So it may be several years. Can he use this note to place a lien on the business's assets? Who is responsible for paying the note? An individual? If recorded at the courthouse, he may eventually have to clear it up with your client in order to ever get credit again, buy a house, car, etc. etc.

[Burke]

Can he actually document the total amount of the loss, i.e, the loaned funds over and above the amount awarded in court? If so, why was the amount reduced? Was there a promissory note or other legal document at the time of the original loan? With interest? Without proper documentation of this sort, IMO, the amount to be written off as a bad debt would be the amount of the current note awarded by the court. And only after that note is determined to be uncollectible. So it may be several years down the road. Can he use this note to place a lien on the business's assets? Who is responsible for paying the note? An individual? If recorded at the courthouse, he may eventually have to clear it up with your client in order to ever get credit again, buy a house, car, etc. etc.