Compensatory or Punitive Damages

[RWG1950]

I have an elderly couple that had been cold called about 4 years ago by a securities broker and the husband had invested about $725,000 in a non-IRA account.
Despite the strong market during this time, apparent account churning and ill-suited investments have caused the account to fall in value to about $450,000.
Customers tell me they are about to hire a securities lawyer and file a FINRA action to arbitrate.
Haven't had a return that would have such an issue before.
If they are able to recover any of their losses, how would anything recovered (to the extent of original investments) be handled ?
How would their legal fees (1/3 of any settlement) and out of pocket costs be handled ?
The taxbook pp 3-19 seems to address some of this.

Anyone out there who has handled this issue on a return care to comment ?

Thanks

[ATSMAN]

About 10 years back I had a similar situation with a cousin who was talked into investing by his "bar buddy" that turned out to be a pyramid scheme. If I recall correctly the amount invested was around $75K and when the truth was out a police report was filed and casualty loss deduction was taken. Because of the lack of recordkkeeping his attorney settled with the so called broker for a fraction of the loss. Obviously the law has changed for 2018 and now we can't deduct legal fees subject to the 2% haircut!

[ATSMAN]

The situation posted is not an (illegal) Ponzi scheme but apparently a case of a naive older couple having their assets managed (poorly and/or for personal gain) by an unscrupulous broker. If they can make their case to the arbitration folks, they may recover monetary damages, although I'm not sure how they could determine the amount of their "loss." That could open a major can of tax worms down the road. Frankly I don't know what would come of that. And I do not see this scenario fitting into a "casualty loss" window.

Good luck to RWG1950. Keep us updated!

FE

I beg to disagree. IRS has already stated that certain ponzi type schemes may qualify. For federal income tax purposes, “theft” is a word of general and broad connotation, covering any criminal appropriation of another’s property to the use of the taker, including theft by swindling, false pretenses and any other form of guile.

[ATSMAN]

>> It appears that your approach to the original post would be just to claim a $275k casualty loss, move onward, and to address the entire event as "criminal." I personally don't see that as a viable approach to the situation posed, especially when/if arbitration with some compensation may be on the radar screen.

In this particular case the other person totally lied about the nature of the investment. It was not a broker subject to SEC jurisdiction. I feel confident based on the facts and circumstances that the taxpayer had this recourse.

[Burke]

It appears to me that he would calculate his loss using the original investment, less the amount he received when the account was terminated, LESS the amount he recovers from the arbitration/lawsuit. Which he won't know until all this is accomplished. (Lets hope by now he has liquidated this account and has the remaining funds in hand.) I am not sure how he can claim a casualty loss since they have now been disallowed except for property losses in a federally declared disaster area. The OP's title seems to indicate he is questioning how to report compensatory damages vs punitive damages. That is addressed in the tax code, and in TTB, but the particulars won't be known until all is settled, monies paid out, and designated in the settlement documents.

[peggysioux]

Re: "I beg to disagree. IRS has already stated that certain ponzi type schemes may qualify. For federal income tax purposes, 'theft' is a word of general and broad connotation, covering any criminal appropriation of another's property to the use of the taker, including theft by swindling, false pretenses and any other form of guile." --- ATSMAN

I despise getting into "arguments" on these boards and, to a large part, have quit posting. . .only lurking. I may need to (again) reconsider my activity.

Now. . .back to lurking in the shadows. I'm getting way too old for this "stuff."

FE

I truly appreciate your input on questions posted on this board and hope you continue to provide.

Peggy Sioux

[DaveO]

Had a case similar to the one FEDUKE404 describes. I had the talk with the client about ongoing losses in the account and the very high fees he was paying (>$30k per year). He went and talked to the broker who responded by offering him a new service; Tax Preparation. My client chafed at my $300 fee so his broker made everyone happy.