A New Jersey Tax court has ruled that investors in Bernard
Madoff’s Ponzi scheme are entitled to refunds on state taxes paid for gains
that never existed. John and Cathy Dalton, a Middletown couple who invested
nearly $700,000 with Madoff, filed amended New Jersey returns for 2005, 2006
and 2007. They had paid taxes on more than $206,000 in capital gains and almost
$37,000 in dividends that proved to be fictitious. They recalculated the taxes
payable, and requested a $5,026 refund. On October 1, 2009, the Division of
Taxation denied the refund, despite the fact that the capital gains and
dividends were non-existent. Their argument was that since the Daltons had withdrawn a portion of their investment in
2002 and 2008, they presumably could
have withdrawn the capital gains and dividends as well. The State’s decision,
however, was overturned by Judge Gail Menyuk. She argued that because the
“capital gains” and “dividends” derived fully from other
clients’ money rather than from actual transactions, there was no constructive
receipt of income .She also pointed out that it would have been impossible for
every Madoff investor to be paid their capital and income, and the state has no
way to tell which ones would have been able to do so. This decision impacts the
many New Jersey taxpayers who invested with Madoff. While the IRS allowed Madoff
victims to claim a theft loss on their federal returns, New Jersey has no
theft-loss deduction. Judge Menyuk’s ruling provides a simple recourse for
those trying to recover NJ taxes paid on their Madoff “income”.