Madoff Victims Ineligible for Insurance Theft Loss Tax Deduction

Victims of the Bernie Madoff Ponzi scheme can’t claim an $8.2 million tax deduction for their investment of life insurance premiums because their investments were made indirectly, the US Tax Court said Monday.

Christopher and Silvana Pascucci, who were New York residents when they filed their petition, didn’t qualify for a theft loss tax deduction under Section 165 on their variable life insurance policies in the years up to the Ponzi scheme that unraveled in 2008, the court said.

The husband and wife’s life insurance premiums had been invested into a “feeder fund,” Tremont Opportunity Fund III LP that was controlled by MetLife, which was deeply invested in the Rye Broad Market Series that invested heavily into Madoff’s Bernard L. Madoff Investment Securities. Because the Pascuccis didn’t have direct ownership of the assets that were invested into the Ponzi scheme, they therefore don’t qualify for theft loss deduction, Judge David Gustafson said.

“As we have held, Mr. Pascucci did not own the assets in the separate accounts maintained by” the entities that controlled the funds, the court said. “Instead, he owned the Policies those companies had issued to him.”

Under Section 165, an individual can seek a deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise” if they can prove that a theft took place, that there is no reasonable chance of recovery, and that they owned the property when the theft occurred.

The couple’s money was invested in Madoff’s scheme in two ways: A family partnership that invested directly in Bernard L. Madoff Investment Securities and lost all of the $9.1 million it had directly invested in the Ponzi scheme, and also indirectly invested the life insurance funds that were managed by MetLife.

On their 2008 tax return, the couple asserted net operating losses of $17.5 million—$9.1 million from the family partnership and $8.2 million from the invested variable life insurance policies—and claimed NOL carrybacks of $6.3 million for 2005, $9.2 million for 2006, and $2 million for 2006. million for 2007, the court said. They were reimbursed about $202,800 through the Justice Department’s Madoff Victim Fund in 2014.

In 2018 the IRS sent the Pascuccis a notice of deficiency of about $3.75 million for tax years 2005, 2006 and 2008, and they petitioned the Tax Court in 2019. In 2022 the IRS granted the losses to the family partnership. But as for the life insurance premiums, the agency said the couple had failed to show ownership of the insurance policies that would make them eligible to claim losses on them.

The court said the losses from their private-placement variable life insurance policy don’t qualify for the tax deduction because of the degree of removal from the direct investment—they had been invested in a MetLife fund which had itself been invested in a fund that had been invested in Madoff’s scheme. And, they were unable to exercise enough control over the funds directly to constitute ownership, the opinion said.

“The Pascuccis cannot have it both ways: They cannot simultaneously enjoy the tax deduction benefit of not owning assets in the separate accounts and also claim a tax deduction that is a benefit available only to someone who owns the assets,” the opinion said.

Eversheds Sutherland LLP represented the Pascuccis. The lawyers declined to comment.

The case is Pascucci v. Commissioner, TC, No. 2966-19, 4/15/24.