The Madoff Tax Advantage

I just received the following e-mail from my accountants, who have several clients invested with Bernard Madoff. They are passing along some year-end tax advice that contains at least a sliver of good news:

Taxpayers who invested in Bernard L. Madoff Investment Securities LLC directly, or through a fund of funds, have a loss that is most probably categorized as a theft loss for tax purposes. This loss has a more favorable tax treatment than theft losses of personal non-business property. Theft loss is determined and applied to get you back taxes for the current year of loss and the three years prior. These losses remain available beyond that four year period, and they can be carried forward for 20 years…

Income for taxpayers who received tax reports from Madoff during the last several years has most likely been overstated, resulting in taxes being paid that should not have been paid. Those taxes should be refunded. The inter-relationship of carrying back theft losses and amending those years during which income was overstated is extremely complex and requires professional advice from tax practitioners skilled and experienced in these matters. Furthermore, in many cases, there will be years affected that are closed by the three year statute of limitations. We will endeavor to use special Internal Revenue Code sections to secure tax benefits from closed years where excessive taxes were paid by clients.

While many advisers are focused on how many dollars can be retrieved for victimized clients, we are also focused on the manner in which we pursue refunds. We may use alternative methods that will give our clients the best opportunity to receive monies quickly and, in the event of challenge by taxing authorities, the best chance of prevailing.

There are many other special situations not mentioned (e.g., how to deal with partnership interests, Roth IRAs) which we would be happy to address on an individual basis. Each state may treat the losses differently, therefore our discussion has been confined exclusively to federal tax treatment. We have established a special task force devoted to assisting clients with these complex tax issues and to help guide them through the process of restoring some of the wealth that was taken away from them by Bernard L. Madoff.

It should also be noted that my accountant, when I spoke to him the other day about routine end-of-year tax issues — I was thankfully never invited to invest with Madoff — said that his firm has never been busier. Just another reminder that an economic cloud, even as thick and black as our current one, does have the occasional silver lining, at least for someone.


So, federal income taxes will be refunded to people who did not do due dilligence. But only those qualified to be able to invest in a hedge fund. So overall revenue will be decreased to benefit these. What about the people who got in early and profited?

Dan Taxes


midwatchcowboy raises an interesting point about gains (from redemptions, since Madoff was paying these). Are these then considered normal capital gains or gifts or what?

As to the "due diligence" canard, that is a nonsensical fiction. You are always limited in how much DD you can do on a fund like this, which is why they have auditors and SEC reviews; DD normally means looking at 3/12/60month earnings, that auditors have a clean bill of health, and the SEC found no problems. Everyone now is more aware that it pays to check the auditor more carefully, and the SEC certainly has some explaining to do.


Well, why the hell should you have to pay taxes on money you never really made? It actually seems fair to me.

Marco Polo

Anyone who thought relying on the SEC for due diligence never heard of Enron. And, it's at least theoretically possible not everyone who was Mad for Madoff will rush to amend their returns. Doesn't an amendment open those bygone returns to audit again, even for other thing the IRS didn't look for or find? That Business Trip on the Orient Express; that condo in Acapulco? You think they want to give the IRS another chance?


I can't help but wonder... if you're a member of an investment team that recommended to your clients that they invest in Bernie's boondoggle, might you now be in a position to further benefit by offering them paid advice on how to untangle the mess that you helped them make of their finances in the first place? I guess that would require that you offer tax accounting services as well as investment advice. But can you imagine the injustice of that?!


Sorry PaulK, but you're mistaken about due diligence, and about the SEC. And it seems that we're to infer from this article that hedge funds are to blame or at a minimum, Bernie Madoff is a hedge fund manager whose hedge fund empire is in trouble because his hedge fund is a Ponzi scheme. This is truncated and unsatisfactory.

The simple truth is that Madoff's behavior is sociopathic. He in fact was able to scheme and steal despite all of the alarms that were rung along the way. But the pragmatic truth is that Madoff is in trouble because he was allowed to take both discretion and custody, and wasn't subjected to any independent assessment or audit, the type to which hedge funds subject themselves. On another note, there doesn't appear to have been a 'hedge fund' at all. There was no partnership structure, management fees or performance allocations. Rather, he owned and operated a brokerage that somehow was able to take investment discretion without registration or regulatory audit.

No institutional investors hired him (though banks acting as introducing, commissionable brokers did). Invariably, large institutional investors who did rigorous analysis rejected him out of hand. Only those who did no due diligence engaged his firm. Worst of all, most of his investors appear to have hired him to discretionarily manage their entire asset base in a single discipline, an imprudent, indeed astonishing thing in a world where diversification is not only the word of action and guiding principle, but easy to achieve.

On another note, Madoff was not registered as an advisory with the SEC until 2006. (His ADV is on the SEC website and he registered September 12, 2006. He remains registered to this day...) Therefore, the SEC would not have audited him until very, very recently, if at all. And so they are not blameworthy in this.



- Kimota94

Investment advisors, distinct from brokerages, owe their clients fiduciary duty, which include care, skill and prudence. And so quite possibly they will be held responsible to some degree.

Further distinction is drawn between those who take discretion and those who don't.

It would be my bet that virtually no discretionary managers would have invested with Madoff... he simply didn't subject himself to any rigorous analysis or audit, a huge red flag.

Feeder funds that invested might well be in real trouble for putting money to work there without any independent verification...

The independent people who looked at him, most especially Harry Markopoulos and Dan DiBartolomeo, both from Boston, found him laughable and reported him to the authorities... Markopoulos later became head of the Boston Security Analysts Society, the oldest and most esteemed society of security analysts in the world.

I will be watching with great interest how they work to back out fraudulently conveyed funds and who might get reimbursed by SIPC.



While it is definitely a windfall for the accountant, it is silly to assume that such a situation is beneficial to our economy. The damage done to investor confidence is likely to have far more a negative impact than the act itself.

"Hetty Green"

Personally, I wonder if all of Wall Street isn't just one grand Ponzi scheme?

Why are ordinary people only allowed to deduct 3000$ in cap losses every year? Why not at least a doubling or tripling of that? (Of course, inflation or robbery never affects the poor only the rich!)

It's all so corrupt., but the powers that be believe in business as usual.


Bruce, I think we agree. My point is that Madoff was running a fund via his company (and him as the fund manager). Normal investors are limited in the DD they can do on this kind of fund, since most funds will only give you their model and basic distribution scheme (geographic and/or industries). He claimed to be using a collaring scheme using options. This is used by others and works.
I agree that most advisers and industrial investors (including most fund of funds) would not touch him since they had too little insight into his funds. Some obviously were investing in him and they were not doing their job.
I also agree that he only registered as an adviser vs. fund management company in 2006, but he was audited as a fund before that.
The final part is that no one disagrees that what he was doing was illegal and outrageous and not defensible in any way. I chalk him up with Enron and Worldcom and other crooks. This was not gray areas such as many arbitrage, futures based, and hedge funds are guilty of - they can only hide bad news for short periods. This was just plain fraud.
The point is that the SEC did do investigations multiple times and somehow came up with nothing. The very fact that his auditor was a 2 man shop for a multi-billion dollar fund company should have been red flag. The fact that they must not have sampled even one trade from this fund tells me a lot. Note that he was also a market maker, so he has a lot of transactions going through his company, but you can check a few sample transactions originating inside to make sure settlements are clean (no skimming or diversions). This is especially true as complaints were filed.
I also agree that anyone who put large portions of their portfolio into one fund were idiots. Some had put into other funds that were then invested into Madoff's fund (without them knowing it), but it looks like the majority were just plain exposed.



Unfortunately this doesn't help the charities that lost so much in the fraud.

Eric M. Jones

Certified: Endorsed by authorities as having met specific requirements or possessing certain qualities; e.g. " Certified Public Accountant", i.e., a person skilled at altering or destroying documents, ignoring or failing to investigate shell companies created by insiders who grotesquely enriched themselves while hiding mounting corporate debt in "off-balance-sheet companies"; Ignoring knowledgeable whistleblowers and accounting "red flags" that indicate massive fraud is taking place; misleading investors who continued pouring their money into failing companies. See "Enron".

Certifiable: Determined to be insane or non compos mentis; e.g. "I know who I am. No one else knows who I am. If I was a giraffe, and someone said I was a snake, I'd think, no, actually I'm a giraffe." - Richard Gere


"midwatchcowboy raises an interesting point about gains (from redemptions, since Madoff was paying these). Are these then considered normal capital gains or gifts or what?

First question to answer before that, is whether or not you're going to have to pay those gains back. If the courts find them to be fraudulent transfers, then you might have to turn them over to the bankruptcy trustee.


Maybe the silver lining will be people waking up to smell the socialist fascism and get ready to return to an actual market economy.


Congrats you rich pigs you have a prior year "Tax Loss"...but the bad news: Give it all to your accountant.

Ahhh Kapitalism


Derick, #15

" smell the socialist fascism and get ready to return to an actual market economy."

I am still waiting for market economy bank failures due to bad mortgage investing...

Kiers, #16,
And don't forget they will be giving it back to the court before the accountant gets some...


21st century capitalism: Private gains, but socialized risk. The winners are always those with money, and the losers are always the taxpayers. Are those hedge fund managers who had Madoff's funds in their portfolios going to give back their 2/20? Probably not.

Abby, Tucson, AZ

This was what folks over at DealBook were saying. Can't have anyone profit from this misery if they don't really deserve it. What I call the "triple forward back flip with a reverse twist" manuver. Folks shouldn't be getting money they don't deserve like those pirates who took Katrina money without even qualifying. We'll see who's a pirate, now.



I think we do agree.

Actually, though, Madoff would not have been subjected to any scrutiny by the SEC... he wasn't registered. My firm has had five. He wouldn't have survived it.

More, he was never privately audited. And indeed prosecutors today dropped their investigation into the firm Madoff claimed was auditing him.

This appears to have happened in his broker dealer... where again he was somehow able to take discretion over client accounts. When things went bad, he fudged it with monies in his custody, then faked documents to cover his tracks.

Rather than advisory or partnership, this is a broker dealer gone bad... not an advisory.

Anyone in the business would have laughed in his face.


Procyclical banking behavior leading to booming credit leading to reckless lending and borrowing is the primary culprit. But risk shifting (what others now call privatize gains and nationalize losses) is a supplemental phenomenon that economists Franklin Allen and Douglas Gale have only recently modeled. Their article 'Bubbles and Crises' is terrific. The math is annoying but the paper is fabulous.