What would you do?

Water Cooler Investing
#1

A close family friend of mine approached my recently with an interest situation he’s in.

Apprently he received a nice inheridance when his grandfather passed. Enough that allowed him to go to any university of his choice, unfortantely his father was the trustee as my friend was a minor at the time. His father invested the inheridance in a high-yeild annuity which ended up being a gaint pyramid scheme.

Fast forward to today, he spoke with a Tax lawyer about his 2014 taxes where he’s trying to figure out if he can deduct the full loss from his ordinary income versus writing off the loss via the standard 3k deduction.The tax lawyer will file on his behalf and include a detailed explaination/justification of why the full writeoff is occuring now versus years ago. There’s a provision in the tax code written specficially for Ponzi Scheme victims (as a result of Madoff’s fraud) that allows one to write off the loss in the year it was ‘discovered’.

He’s telling me if he writes off the full balance he’ll receive ~15k refund this year, opposed to about 450 for the next 30 or so years. The tax lawyer will file on his behalf and include a detailed explaination/justification of why the full writeoff is occuring now versus years ago.

BUT the potential issue is the IRS may or may not audit him within 3-years of the statute of limitations. If he is audited the IRS may or may not agree with the Tax Lawyers assestment and the full 15k will be requested back + about 36% interest (1% per month for 36 months) so 20k or so - assuming worst case scenario.

I did some quick math and I think the benefit of 15k today versus 15k over 30+ years (450/year)is clearly ‘better’. BUT is the risk of an IRS audit worth it?

I really didn’t know what to say to my friend since it’s clearly a difficult decision. Thoughts?

#2

I don’t think that the IRS charges that much interest. Where do you get 1% per month?

I would go for the 15k refund and then be prepared to go to tax court if challenged.

#3

That’s what his tax guy suggested could be the interest penalty, I also thought it sounded high.

#4

That rate sounds more like a State imposed interest rate, which is usually capped at something like 18%. IRS interest rates are low, like 5-6% per annum these days.

#5

Let me get this straight–15k for one year is better than 15k/year for 30 years?

#6

And I agree with JB. I wouldn’t worry about federal interest. Right now it’s extremely low. I’d worry more about the audit.

And the lawyer gets paid to understand stuff like this. I’d go with what the lawyer says. (Otherwise, why are you paying him?)

#7

Sorry I wrote it poorly.

15k now or $450.00 a year for 30 years

#8

I think the idea of the lawyer was to understand what makes sense ‘in court’ if an audit were to arise and weigh the costs vs. potential benefits.