How the Government Screwed Madoff Victims Again

For years, hundreds of Madoff clients paid taxes on income they thought they had earned. Now that Madoff’s alleged scam has unraveled, investors like The Daily Beast’s Burt Ross are fighting the government to get their money back.

03.08.09 7:07 AM ET

Those of us fleeced by Bernard Madoff are looking to get some of our money back from the government, which taxed us on money we never earned. In my case, I not only lost $5 million in the Ponzi scheme, but I paid almost $75,000 to the state of New Jersey and $275,000 to Uncle Sam in taxes over the past three years on income reported by me, which, as we all know now, never existed.

We Madoff investors, creditors, survivors—please call us anything other than victims—realize we will get back pennies on the dollar from Madoff if we’re lucky, but getting back the money we paid the government and which we’re entitled to apparently won’t be easy.

Madoff robbed me of $5 million and New Jersey now wants to rob me of $75,000.

Take New Jersey, for instance. On Feb. 20, the New Jersey Division of Taxation came forth with a “Ponzi Schemes and Amended Returns” notice on its website acknowledging that “many people with investments managed by Madoff are likely to have paid taxes on income that was never actually generated by them (phantom income).”

Rather than urge taxpayers to amend their tax returns to get a refund, the division does the exact opposite. “The Division of Taxation is not accepting amended returns with regard to the Bernard Madoff or other alleged Ponzi schemes,” the notice states. It goes on to advise taxpayers to claim a loss of investment that can be taken against capital gains in the year of the loss. Since almost nobody has a capital gain in 2008, the net effect of this notice is simple—Madoff robbed me of $5 million and New Jersey now wants to rob me of $75,000.

The state might be reconsidering. On March 2, the notice was gone, replaced with: “The page you have requested cannot be displayed because it does not exist, has been moved, or”—and this is the part I like best—“the server has been instructed not to let you view it.” Things got even more interesting on March 3, when the reference to the notice disappeared entirely. The Madoff investors living in New Jersey have no clear instructions from the state, but come hell or high water, we will submit our amended returns. We are not asking for a bailout, just for our money back.

The federal government hasn’t given such mixed messages—it has given no guidance whatsoever. Although thousands of investors across the country are eagerly awaiting some pre-April 15 instruction, the IRS remains eerily silent. If transparency and communication are the linchpins of the new administration, the folks over at the IRS haven’t gotten the message.

New York Reps. Joseph Crowley, Anthony Weiner, and Gary Ackerman recently wrote IRS Commissioner Douglas Shulman strongly urging that overall guidance be forthcoming. Members of the Senate Finance Committee and the House Appropriations Committee will likely question the commissioner this month about the IRS’ reluctance to provide such guidance. We Madoff survivors are not seeking special treatment but some clarity on what to do when we file.

Are we to consider 2008 or 2009 the year in which we discovered the loss? Should we amend our tax returns to recover the taxes we paid on phantom income and then take a theft loss deduction separately? Do we need to wait until the Securities Investor Protection Corporation pays the claims before taking the tax loss? These are highly technical questions, but the answers to them will have a great impact on how the investors proceed and how much of our taxes we are ultimately able to recover.

The stony silence of IRS is compelling thousands of us to hire tax counsel and to proceed at our own risk and expense. Imagine an elderly widow trying to make heads or tails out of this maze of complicated tax law. We are heading for a preventable disaster—each taxpayer will march to his own drummer with agents across the country conceivably taking different approaches and the litigation tying up tax courts everywhere for years to come. Who possibly can be served by this lack of uniformity and clarity other than the lawyers?

Let us remember that governmental negligence caused this catastrophe in the first place. Had the SEC done even a half-assed job, the Ponzi scheme would have been discovered a decade ago. Now, after allowing it to go undiscovered until it caused incalculable suffering, the same government is financially benefiting by collecting taxes on the scam. The least it could do is put the crook behind bars and give us our money back.

Burt Ross, former mayor of Fort Lee, New Jersey, and former administrator of the New Jersey Energy Office, is a lawyer and real-estate investor. A book "The Bribe" was written about his exploits with the Mafia.