Tax Court: Estate entitled to theft loss incurred by family LLC

Estate entitled to theft loss incurred by family LLC

The U.S. Tax Court today—in a case of first impression—held that an estate is entitled to a theft loss deduction under section 2054 when the estate’s interest in a family limited liability corporation (LLC) suffered a loss due to a Ponzi scheme. The court rejected the IRS’s claim that no theft deduction could be allowed because the LLC, and not the estate, suffered the loss.

Related content

The case is: Estate of Heller v. Commissioner, 147 T.C. No. 11 (September 26, 2016). Read the Tax Court’s opinion [PDF 48 KB]

Background

The decedent, at time of his death in January 2008, owned a 99% interest in a family LLC. The LLC’s only asset was an account held by Madoff Investment Securities. Between March and November 2008, one of the co-executors withdrew amounts from the Madoff account, the estate’s portion of which was used to pay the estate taxes and administrative expenses. In December 2008, Bernard Madoff, the chairman of Madoff Securities, was arrested, and charged him with securities fraud relating to a multibillion-dollar Ponzi scheme. Subsequently, he pleaded guilty to various federal crimes, including securities fraud, investment adviser fraud, money laundering, and perjury. 

Because of the Ponzi scheme, the LLC’s interest in the Madoff account and the estate’s interest in the LLC became worthless. The estate on April 1, 2009, timely filed Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, on which a gross estate of approximately $26.3 million was reported, including the value in the LLC (approximately $16.5 million). The estate also claimed a theft loss deduction of approximately $5.2 million relating to the Ponzi scheme (that is, the difference between the value of the estate’s interest in the LLC reported on the estate tax return and the estate’s share of the amounts withdrawn from the Madoff account.)

The IRS issued to the estate a notice of deficiency, determining that the estate was not entitled to the theft loss deduction because the estate did not incur a theft loss during its settlement—but that the theft loss was that of the LLC. The estate filed a petition with the Tax Court, and then a motion for summary judgment.

Tax Court’s opinion

The Tax Court today issued an opinion concluding that the estate was entitled to deductions relating to “losses incurred during the settlement of * * * [the estate] arising * * * from theft” pursuant to section 2054. As noted by the court, this issue—that is, whether an estate is entitled to a section 2054 theft loss deduction relating to property held by an LLC—was one of first impression. As the court noted, neither the regulations nor the legislative history relating to section 2054 (or its predecessors) addressed this issue. 

While the IRS conceded that Madoff Securities defrauded the LLC, the IRS also contended that the estate was not entitled to a section 2054 deduction because the LLC incurred the loss, not the estate. However, the Tax Court explained that section 2054 allows for a broader nexus (i.e., between the theft and the incurred loss) than did the “narrow interpretation” by the IRS. The Tax Court concluded that the phrase “arising from” in section 2054 allows the estate a deduction “if there is a sufficient nexus between the theft and the estate’s loss.” Here, the loss suffered by the estate related directly to its interest in the LLC and the worthlessness of which arose from the theft.

© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.

Connect with us

 

Request for proposal

 

Submit

KPMG's new digital platform

KPMG's new digital platform