Tax consequences for investors in hedge fund frauds

Abstract

Purpose

The purpose of this paper is to consider the appropriate Internal Revenue Service (IRS) tax filings for individual and fund‐of‐fund (FOF) investors who have incurred losses from hedge fund fraud.

Design/methodology/approach

The paper describes the types of losses investors have suffered; explains the types of relief the IRS provides; recommends the steps investors should take in filing claims; discusses special issues for FOFs, recoveries from the Securities Industry Protection Corp. (SIPC), treatment of litigation expenses, and recent IRS guidance; and provides a sample tax‐claim calculation.

Findings

For defrauded investors, two types of relief may be available: filing a tax return for the taxable year in which the fraud is discovered to claim an ordinary loss from theft for the entire adjusted basis in the fraudulent investment; and filing for refunds of tax erroneously paid in prior years on income fictitiously reported by the Ponzi scheme.

Originality/value

The paper provides timely guidance from an expert on tax issues related to hedge funds. Readers need to be aware that resolution of many issues discussed here is uncertain and the subject may be characterized as a “moving target”.

Citation

Lorence, R.D. (2009), "Tax consequences for investors in hedge fund frauds", Journal of Investment Compliance, Vol. 10 No. 2, pp. 18-23. https://doi.org/10.1108/15285810910971247