October 3, 2016
Authored by: Stacie J. Rottenstreich and Karin Barkhorn
In a recent Tax Court decision, Harry H. Falk, and Steven P. Heller, Co-Executors, v. Commissioner of the Internal Revenue, the United States Tax Court ruled that in the case of the Madoff Ponzi scheme, an estate which paid estate tax on Madoff assets which subsequently have become worthless can claim a theft deduction.
James Heller, a New York state decedent, died in January 2008 owning a 99% interest in James Heller Family, LLC (the “LLC”). The only asset held by the LLC was an account with Bernard L. Madoff Investment Securities, LLC. In November of 2008, the Executors of Mr. Heller’s estate withdrew some money from the LLC’s Madoff account in order to pay estate taxes and other administrative expenses. Shortly thereafter, the news of the Madoff Ponzi scheme became public. Suddenly, the LLC’s interest and the estate’s interest in the LLC became worthless.
In April 2009, the Executors of the Estate filed an estate tax return which included the decedent’s 99% interest in the LLC – as valued at the date of his death – in his gross estate. But the estate also claimed a theft loss deduction relating to the Ponzi scheme in an amount equal to the difference between the values of the estate’s interest in the LLC at death and the estate’s share of the amount withdrawn from the LLC’s Madoff account. The Internal Revenue Service issued a notice of deficiency, claiming the estate was not entitled to the theft loss deduction because the estate did not incur a theft loss.
Internal Revenue Code Section 2054 allows a deduction from the value of a gross estate of “losses incurred during the settlement of estates arising from…theft.” The Internal Revenue Service argued that the LLC incurred the loss, not the estate, and as such the theft deduction is not appropriate. However, the Court determined that the loss suffered by the estate related directly to its LLC interest, the worthlessness of which arose from the theft. The theft extinguished the value of the estate’s LLC interest, thereby diminishing the value of the property available to the decedent’s heirs. As such, the Court determined a theft deduction appropriate.