Friday, November 25, 2011

New Jersey Couple Scores a Victory Against Bernie Madoff and the Division of Taxation

The New Jersey Tax Court recently held that a married couple was entitled to recover the Gross Income Tax (GIT) paid on dividends and capital gains reported as earned through their investments with Bernie Madoff. The taxpayers filed a claim for refund of gross income taxes paid by them for the tax years 2005, 2006 and 2007 with respect to capital gains and dividend income reported as earned through their investments with Madoff. They learned in 2008, that, in fact there had been no earnings, and that Madoff’s report to them of various security transactions and income earned from those transactions were fictitious. The Division of Taxation denied their refund claims.

The Division refused to stipulate to the facts surrounding the operation of the Madoff Ponzi scheme, however, the Director implicitly accepted the factual underpinnings of the plaintiff’s case in his official pronouncements with respect to the Madoff scheme; the court concluded that those facts constituted stipulated facts.

The taxpayers argued that they were entitled to refund of taxes paid on their factitious income. They also argued that their election to treat the loss as a theft loss on their federal income tax return did not preclude them from claiming refunds under the GIT Act. The Division of Taxation contended that the dividends and capital gains income were taxable because the taxpayers constructively received the income. They also argued that pursuant to its April 15, 2010 notice, victims of the Madoff fraud may only report a capital loss in 2008, the year in which the fraud was discovered and in accordance with the federal procedures for theft losses.

The Tax Court held that the taxpayers were entitled to income tax refunds because the dividends and capital gain income reported on their tax returns simply did not exist. The Tax Court found that there was never any sale, exchange or other disposition of property because the transactions reported by Madoff sent to the taxpayers never took place. The court then held that the Division of Taxation’s position that the only relief available to the taxpayers was to claim a capital loss in accordance with federal procedures was unreasonable. It found that there was no principal reason why the taxpayer should be required to use a federal procedure that relies upon federal tax code concepts that are not recognized by the Gross Income Tax Act. The court then found in favor of the taxpayers allowing the theft losses against the taxpayers gross income tax.

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