January 5, 2009…Mineola, New York…Mineola, New York…Madoff victims may obtain maximum tax refunds and net operating loss deductions according to Stephen M. Breitstone, tax partner at Meltzer, Lippe, Goldstein & Breitstone, LLP. "The Internal Revenue Code contains provisions that may allow victims to overcome barriers to recovery - such as a three year statute of limitations on filing for tax refunds. The IRS has a certain amount of discretion to make it easy or hard for victims. It is unclear whether the IRS will choose to grant relief without a fight. The potential for refunds can be maximized through careful planning. It will be like a game of chess with the IRS" said Steve Breitstone. How one invested - whether directly or with a partnership - may make a difference in the ability to recover from the IRS.

It is critical that "Feeder Fund" investors - such as those in a hedge fund - get their own tax counsel according to Steve Breitstone. Typically, individual partners of an investment partnership do not have standing with the IRS. Instead, a designee known as the "tax matters partner" is the partnership's IRS representative. Given that the interests of the various partners in a feeder fund may differ, it is critical that individual partners reserve their right to take a position inconsistent with the partnership. Direct investors of Bernard L. Madoff Investment Securities LLC may be in a much better position to get relief from the IRS than those who invested through a feeder fund that is a partnership.

Madoff victims fall into two general categories. In category one are investors who took income and/or principal out of their accounts. Investors who took little or no money out fall into category two. Both categories of investors paid income taxes on fictitious earnings. But, category one investors may now be subject to additional financial losses in the form of "clawbacks". Clawbacks require investors to repay distributions that are then redistributed among all investors and other creditors. There is legal precedent for this. On December 19, 2008 The New York Times reported that a bankruptcy judge involved in the collapse of the Bayou hedge fund ruled that investors who withdrew money from the Bayou fund may have to return it. A similar decision may occur in the Madoff case.

Irrespective of which category they fall into, many Madoff victims should be able to claim a theft loss deduction on 2008 returns. "Timely filing is imperative to maximizing the theft loss carryback" said Stephen Breitstone. If a claim is filed on the 2009 return rather than the 2008 return, the loss can only be carried back to 2006 verses 2005 for those filing a claim in 2008.

The more difficult question is whether it is possible to obtain tax refunds on phony Madoff income from periods earlier than 2005. There is a three year statute of limitations for filing amended tax returns. In this case, being in category one or two makes a difference. Victims required to forfeit funds under a clawback should have an easier case for obtaining a refund of the income taxes paid in years beyond the three year statute of limitation. But, for category 2 victims, who didn't withdraw the fictitious income, the statutory basis for obtaining refunds for the earlier years is less direct. To obtain these refunds will require more careful planning - which should begin prior to filing amended returns for the more recent periods and prior to claiming the theft loss carryback. With a proper strategy, these victims may obtain relief under the statute of limitations mitigation provisions in the Internal Revenue Code.

It is possible that the IRS may issue guidance to victims as the repercussions of the Madoff Ponzi scheme unfold. In the meantime, Steve Breitstone believes victims should retain counsel to ensure they are not further victimized.