Article

Note: The U.S. Commissioner of Internal Revenue (IRS) issued a statutory notice of deficiency per section 6212 of the U.S. Internal Revenue Code to Paula Halata (Taxpayer) for income tax deficiencies. In 2006, Dominique Ojeda (Taxpayer's Girlfriend) corresponded with Dwight Montgomery (Broker) regarding a bank-guarantee transaction. Broker informed Taxpayer's Girlfriend that if she made a payment of USD 180,000, she would receive USD 2,500,000 in return. Taxpayer advanced the money. When Broker failed to make payment, Taxpayer's Girlfriend contacted Broker again. Broker responded that Taxpayer's Girlfriend had only been guaranteed money back if a company agreed to enter into the bank-guarantee transaction, which had not occurred. Taxpayer's Girlfriend made unsuccessful attempts to get Taxpayer's money back, but Taxpayer did not pursue legal action against Taxpayer's Girlfriend or Broker.

Taxpayer did not report a theft when she filed her taxes in 2007, nor did she file an income-tax return for 2008. In 2009, the IRS began an examination into Taxpayer's taxes for the years 2007 and 2008. In December 2009, the IRS issued a notice of deficiency to Taxpayer, which did not include deductions relating to the theft losses which occurred in 2006. Taxpayer filed a petition asserting that because the financial loss was the result of a theft, she was entitled to a theft-loss deduction under the Internal Revenue Code, 26 U.S.C. § 165(a). The United States Tax Court, Morrison, J., denied the petition.

The Judge observed that while Taxpayer would have been entitled to the deductions for the theft loss, because Taxpayer did not file the proper pleading with the IRS regarding the theft loss, the deduction to her taxable income only applies to the year 2009, when the investigation by the IRS occurred, and not 2007, the year that the loss first affected her taxes. Section 165(a) provides that a taxpayer may claim a deduction against income for "any loss sustained during the taxable year and not compensated for by insurance." The rule also provides that the taxable year to which the deduction is applicable is the year that the taxpayer discovers the loss. While the IRS claimed that the bank-guarantee transaction should be regarded as an investment, because there was no formal contract and the agreement resembled a scam, the court found that the loss was the result of theft and Taxpayer was therefore eligible for a theft loss deduction. However, because Taxpayer did not properly raise the issue to the IRS for the 2007 and 2008 taxable years, the deficiencies that occurred in those two years were not impacted by the theft loss. Therefore the court concluded that Taxpayer was still responsible for the payment of the deficiencies which resulted in 2007 and 2008.

Comment: This decision overlooks the psychological aspect of commercial fraud. It takes a while for victims to realize that they have been defrauded and even longer to admit it. It may be of some comfort to victims, however, to know that if they wake up soon enough, they can deduct the loss.

[JEB/agj]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.