Question

Research Assignment

Boris Badenov

In 2011, Rocket (Rocky) J. and Bullwinkle J. Moose (R&B) who are married filing jointly (MFJ) invested the sum of $250,000 with Boris Badenov, who held himself out to the public as an investment and securities broker. R&B gave Badenov a power of attorney to use the $250,000 sum to buy and sell securities on their behalf. Any income or gains on this initial investment were to be reinvested. In 2012, R&B contributed an additional $50,000, in 2013 an additional $40,000 and in 2014 they contributed an additional $10,000. Badenov periodically issued account statements to R&B that reported the securities purchases, sales, and re-investments that Badenov purportedly made in their investment account. He also issued tax forms and statements to R&B and to the IRS that reflected purported gains and losses on their investment account. Badenov reported to R&B and the IRS that income in 2011 was $25,000, $35,000 in 2012, $65,000 in 2013, in $75,000 in 2014 and $80,000 for each of the years 2015 – 2017. R&B included all of these amounts in their federal gross income on their annual income tax returns. R&B took distributions of $25,000 for each of the years 2013 through 2016 in order to pay for their daughter’s college education. No other distributions were made from the account.

In 2018 it was discovered that Badenov’s purported investment advisory and brokerage activity was in fact a fraudulent Ponzi scheme, and that his reported investment activities and the resulting income amounts for his investors were partially or wholly fictitious. When Badenov’s fraud was discovered in 2018, he had only a small fraction of the funds that he reported on his investors’ account balances. As a result, investors would never receive the amount in their account balance and would receive no reimbursement or other recovery for the loss of these funds. Badenov’s actions constituted criminal fraud or embezzlement under the laws of their state. R&B had no prior knowledge that Badenov’s activities were a fraudulent scheme. Tax years 2011 through 2014 are closed for R&B (the statute of limitations being three years for their federal income tax returns), but years 2015 through 2017 were still open.

Begin by referring to Standard Federal Tax Reported (2020) 10,101.026, Theft and Embezzlement: Losses from Ponzi Schemes. Then look at IRC § 165, Regs. §1.165-8, Revenue Ruling 2009-9 and Revenue Procedure 2009-20 included in these materials. Check the dates of promulgation for each of these documents to check the ordering and predominance. Find very helpful step-by-step calculation instructions in Revenue Procedure 2009-20 and safe harbor rules in Revenue Procedure 2011-58.

Important: This assignment is completed in two parts: Tax Memorandum, and Ethical Essay. The Tax Memorandum is 90% and the Ethical Essay is 10% of your grade for this assignment. Read this entire assignment before beginning your work.

Part One - Tax Memorandum: Based on the information provided above, prepare a tax memorandum using the “Bull & Bear” template provided on Blackboard. Be sure to cite your sources following the example in your textbook. Be sure to also provide headlines to each paragraph of this memo. In addition, attach your sources/backup to the tax memorandum you upload, as described in the Tax Research Training videos.

Issues:

1. What is the character of Rocky’s and Bullwinkle’s loss? Under what IRC Code Section?

2. What amount is deductible to R&B?

3. What year(s) may R&B take such deductions?

4. How would R&B report any recovery of funds in subsequent years?

The tax memorandum should be no more than four single-spaced pages long. BE SURE TO INCLUDE AN EXCEL SPREADSHEET THAT SHOWS YOUR CALCULATIONS OF THE DEDUCTION(S) AND EMBED IN THE MEMO.