On October 19, 2020, the Tax Court issued a Memorandum Opinion in the case of Giambrone v. Commissioner (T.C. Memo. 2020-145). The primary issue before the court in Giambrone v. Commissioner is whether the IRS improperly disallowed a theft loss deduction that the petitioners claimed on their respective 2012 returns.A Few Opening Words to Giambrone v. Commissioner
I am not going to say that the Giambrones are in the mob. That would be reckless and without any basis other than their likely Sicilian heritage. Nonetheless, you, dear reader, may draw your own conclusions.
Background in Giambrone v. Commissioner
The Giambrone family was in “real estate.” Not content to lend money (and break kneecaps when absolutely necessary), the Giambrone brothers Michael (Little Mikey) and William (Willy the Fist) founded Platinum Community Bank (Platinum), a federally chartered stock institution with its home office in Rolling Meadows, Illinois – just northwest of Chicago, land of deep dish pizza, the Cubs, and Al Capone. I’m just saying.
To raise capital, Platinum’s holding company entered into a stock purchase agreement with TBW, a Florida corporation. (Florida was where Capone lived when he was arrested for tax evasion. Just saying.) TBW acquired an 83% interest in the holding company, and the Giambrone family retained a 9% interest. TBW, as the majority shareholder in the holding company caused Platinum to purchase $481 in TBW mortgage loans. Platinum was unable to sell the loans back to TBW or to third parties, and ultimately the government shut down Platinum, and it was placed into receivership by the FDIC.
To the shock of no one, the head of TBW was indicted for bank, wire, and securities fraud, and he was ultimately sentenced to 30 years in the federal penitentiary. Whether he met an unfortunate fate, the opinion does not say – but if he thinks prison walls are going to protect him from Willy the Fist, he has another thing coming. Just saying.
Claim of Theft Loss
The Giambrones claimed theft loss deductions of 95% of the value of the investments in Platinum on their 2012 Federal income tax returns. The Giambrones premised their claimed deductions on Rev. Proc. 2009-20, which provides “an optional safe harbor treatment for taxpayers that experienced losses in certain investment arrangements discovered to be criminally fraudulent.”
Notices of Deficiency
On March 20, 2018, the IRS issued separate notices of deficiency to Little Mike and Willy the Fist (and the Fist’s wife, simply known as Mugs), disallowing the claimed theft loss deductions on the ground that the Giambrones had failed to satisfy the revenue procedure’s requirements.
Theft Losses Generally
A taxpayer is entitled to deduct uncompensated losses resulting from theft. IRC § 165(a), (c), (e). To qualify for a theft loss deduction, a taxpayer must prove:(1) the occurrence of a theft, (2) the amount of the theft loss, and (3) the year in which the taxpayer discovers the theft loss. See IRC § 165(a), (b), (c), (e).
As used in IRC § 165, the term “theft” is a word of “general and broad connotation,” and it is intended to cover any “criminal appropriation’ of another’s property, including theft by larceny, embezzlement, obtaining money by false pretenses, and “any other form of guile.” Littlejohn v. Commissioner, T.C. Memo. 2020-42, at *26; see also Bellis v. Commissioner, 61 T.C. 354, 357(1973), aff’d, 540 F.2d 448 (9th Cir. 1976); Treas. Reg. § 1.165-8(d). Any loss arising from theft is treated as having been sustained during the taxable year in which the taxpayer discovers such loss. IRC § 165(e); see also Treas. Reg. § 1.165-1(d)(3).
Revenue Procedure 2009-20
In April 2009, the IRS published two pieces of administrative guidance—Rev. Rul. 2009-9 and Rev. Proc. 2009-20—as to the proper treatment of losses from certain investment arrangements later discovered to be fraudulent. Rev. Rul. 2009-9 addresses the tax treatment of losses from Ponzi schemes in the light of IRC § 165 and its accompanying regulations. Rev. Proc. 2009-20, on the other hand, provides an “optional safe harbor,” under which “qualified investors” may treat a loss as a theft loss deduction when certain conditions are met. Rev. Proc. 2009-20, § 2.04.
The safe harbor is made available to a “qualified investor” who experiences a “qualified loss”. Id. at § 5.01. A qualified loss is defined to include a loss “from a specified fraudulent arrangement in which, as a result of the conduct that caused the loss” the lead figure was charged by indictment or information with the commission of “fraud, embezzlement or a similar crime that, if proven, would meet the definition of theft for purposes of IRC § 165.” Id. at § 4.02(1). A “specified fraudulent arrangement,” in turn, is defined as one in which the lead figure receives cash or property from investors; purports to earn income for the investors; reports income amounts to the investors that are partially or wholly fictitious; makes payments, if any, of purported income or principal to some investors from amounts that other investors invested in the fraudulent arrangement; and appropriates some or all of the investors’ cash or property. Id.
Further, a “qualified investor” is defined as one qualified to deduct theft losses under IRC § 165 who “did not have actual knowledge of the fraudulent nature of the investment arrangement prior to it becoming known to the general public. Id. at § 4.03(2).
As relevant to this case the safe harbor permits the deduction of 95% of a qualified investor’s “qualified investment,” which is defined as the amount associated with the arrangement that can be considered for purposes of calculating the deduction. Id. at § 5.02(1)(a). Specifically, Rev. Proc. 2009-20 at § 6.01(1) clarifies that the safe harbor “must” be claimed on the “federal income tax return for the discovery year.” The “discovery year” is defined as the taxable year of the investor in which the indictment, information, or complaint described in § 4.02of Rev. Proc. 2009-20 is filed. Id. at § 4.04.
Revenue Rulings not Held in the Highest Esteem by Tax Court
As a preliminary matter, the Tax Court notes that revenue procedures are not actually binding on the court. See, e.g., Raifman v. Commissioner, T.C. Memo. 2018-101, at *48; 6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *50, n. 24. (This is the old line to the babysitter that “you’re not my real mom.”) Further, they do not, as a general matter, confer substantive rights on taxpayers. See Capitol Fed. Sav. &Loan Ass’n v. Commissioner, 96 T.C. 204, 216-217 (1991); see also Estate of Shapirov. Commissioner, 111 F.3d 1010, 1018 (2d Cir. 1997), aff’g T.C. Memo.1993-483.
Courts have straight-up refused to invalidate the IRS’s determinations arising out of the IRS’s failure to abide by their own revenue procedures. See Capitol Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C. at 217. Thus, even if the Giambrones had established that the IRS had erred in its application of Rev. Proc. 2009-20, the Tax Court would not be required to conclude that they are entitled to the claimed theft loss deductions. In any event, the Tax Court concludes that the Giambrones “plainly did not qualify” for the safe harbor.
The “Discovery Year”
According to Rev. Proc. 2009-20 at § 4.04 and § 6.01(1), a taxpayer must elect “safe harbor treatment” on the tax return “for the discovery year,” which is defined as the year in which an indictment, information, or criminal complaint is filed against the lead figure. As relevant to this case, the ringleader of the TBW scheme was indicted in June 2010, making 2010 the discovery year. To avail themselves of Rev. Proc. 2009-20, supra, the Giambrones were required to claim safe harbor treatment on their respective 2010 Federal tax returns. They did not do so and, accordingly, the Tax Court held that they were not eligible for the safe harbor.
The “C’mon” Argument of the Brothers Giambrone
The Giambrones did not dispute that they failed to request safe harbor treatment on their 2010 Federal tax returns. They asserted, however, that the definition of “discovery year” set forth in Rev. Proc. 2009-20 is incompatible with IRC § 165(e) and Treas. Reg. § 1.165-1(d)(3), and, therefore, they qualified for the safe harbor under the broader terms of the Code and the accompanying Treasury Regulation. When asked to elaborate, the Fist merely cracked his knuckles and smiled at Judge Urda, who was unpersuaded.
The Unpersuaded Response of the Tax Court
The Tax Court observes that Giambrones were “laboring under a fundamental misconception,” to wit: Rev. Proc. 2009-20, is not required to comport with the terms of IRC § 165 (or the accompanying regulation). It is an exercise of administrative discretion on the part of the IRS, offering beneficial treatment for categories of theft losses meeting certain well-defined conditions. The Giambrones cannot gain the benefit of the Revenue Procedure without adhering to its burdens (i.e., the conditions imposed by the IRS). See, e.g., Beech Trucking Co. v. Commissioner, 118T.C. 428, 444 (2002).
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