Protections for Ponzi scheme victims
In the wake of Bernie Madoff's Ponzi scheme at the end of 2008 when thousands of investors lost more than $60 billion, the IRS introduced guidance to relieve taxpayers suffering from losses because of financial fraud and Ponzi schemes.
"The provision to claim 'casualty and theft loss' deductions existed even before 2009, but the introduction of IRS Rev. Ruling 2009-9 made the process and eligibility criterion easy to understand for everyone," said Carlos Guaman, a California-based accountant. He represents taxpayers in disputes with the IRS.
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Specifically, this ruling serves as a guide to whether an individual's specific loss because of investments in fraudulent Ponzi schemes qualifies for a theft loss deduction for tax purposes or not.
Protect your identity
Identity theft and the resulting issuance of fraudulent tax refunds is also a huge problem for the IRS as well as a burden on taxpayers.
For the 2010 tax year, $5 billion in tax refunds were issued by the IRS as a result of identity theft tax fraud according to a report released by the U.S. Treasury Inspector General for Tax Administration. The report issued last year also estimates another $21 billion will be issued in potentially fraudulent tax refunds resulting from identity theft over the next five years.
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Identity thieves may use your Social Security number to be paid by an employer or to file a fraudulent tax return for refunds like in the case of California resident Daniel Ramirez who has been a victim of identity theft.
At the end of 2011, Ramirez started receiving statements for maxed-out new store credit cards. On realizing that somebody has stolen his identity, he took the necessary steps of informing the credit bureaus and freezing his credit accounts temporarily. While most people stop there, Ramirez went beyond that and even filed an Identity Theft Affidavit, Form 14039 with the IRS envisioning potential tax fraud issues.
Yet, when Ramirez tried to file his tax return online in April 2012, the system refused to accept it. "The person who had stolen my identity filed the taxes before I could and they were claiming a refund of like $10,000," said Ramirez.
But thanks to Ramirez's forward thinking and filing the identity theft affidavit, the IRS had flagged his account and stopped that refund from going to the identity thief. Even though it took a "number of follow-up calls to the IRS and a whole year to process," Ramirez eventually received his due refund earlier this year.
"It [identity theft] was one of the worst things ever, I wouldn't wish that on anybody," Ramirez recalled. "Dealing with the IRS, having to close fraud credit card accounts, cleaning all that mess up was very stressful."
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While the IRS provided us with data and other information for this article, a spokesperson declined to comment on any individual cases.
If worried about being at risk of identity theft:
1. Contact the IRS Identity Protection Specialized Unit at 1-800-908-4490
2. Order a tax account transcript from the IRS that verifies basic personal data along with details of your tax return filed, which may come in handy if you are checking to see whether someone else filed a fraudulent return on your behalf
The Federal Trade Commission also lists several steps you must take if you have been a victim of identity theft.
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—By Divya J. Verma, Special to CNBC.com. Follow her on Twitter @divya_verma.