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Abstract: 

In the liquidation of a Ponzi scheme, investors—typically those who were “net winners” (i.e., investors who, over time, received more cash than they deposited)—may find themselves facing a lawsuit in the ensuing bankruptcy seeking to “claw back” all or some portion of their net winnings and sometimes even amounts representing “principal.” In the Madoff bankruptcy, for instance, the trustee in charge of the liquidation proceedings filed over 1,000 lawsuits seeking to claw back funds from former customers. In September 2012 the IRS released guidance in the form of two FAQs posted on its website addressing the federal income tax treatment of clawback repayments of amounts previously reported as income from a Ponzi scheme. This article analyzes the application of the IRS’s guidance to clawback repayments of net winnings and the need for future guidance regarding the tax treatment of clawback repayments of principal.

Keywords: Ponzi, Madoff, clawback, claim of right, IRC Sec. 1341

Affiliations:  1: Roberts & Holland LLP; 2: Drinker Biddle & Reath LLP.