Business Opportunity Fraud, Deductable?

[GlimDropper]

The fact that a significant number of people fall victim each year to a fairly staggering array of fraud comes as no surprise to almost anyone here. Some people seem born without a BS detector and others with almost incredible levels of BS and the internet just makes it so much easier for those people to meet each other. The result of those interactions is depressingly predictable.

So yea, a lot of people are getting ripped off. But under what circumstances are losses due to getting swindled deductible from federal taxes?

In the wake of the Madoff scandal there is a fair amount of information in public circulation regarding the tax implications of investment related fraud. For anyone finding this topic looking for that information I'll provide just a few links: [1] [2] [3]. But not all fraud is "investment" related, I know investment related investigations (on a federal level) are issues for the SEC while deceptive and unfair trade practices are more a matter for the FTC. Is there a similar distinction in the tax code?

Hypothetical example: Johnny Sleaze markets a "work at home" business opportunity. Using slick promotional materials he represents that in exchange for a modest up front fee and small recurring charge, someone without any particular skill set can quite easily earn a substantial income in only a few hours per week. If anyone thought critically about the business model that Johnny describes they'd be tempted to wonder why he didn't just hire a number of people to perform the requisite task and retain what's purported to be an incredible profit for himself. This seem to assure that critical thinkers make up almost none of the people paying to participate in Johnny's business opportunity.

Johnny has been marketing this opportunity for many years, due perhaps in part because the total amount of money he receives from any one person before they become disaffected with his offer is too low to justify retaining an attorney and filing a lawsuit and the almost happy coincidence very few of the people he markets the opportunity to are in a physical proximity to file against him in local small claims court.

But one day, after a sufficient number of consumer complaints, the FTC files suit against Johnny and his company. The wheels of justice turn slow and while they do Johnny not only continues marketing his opportunity but sharply increases his prices.

Billy Bumble isn't the sharpest tool in the shed, in fact he's an elderly gentleman with diminished capacity. In the period of time after the FTC filed suit against Johnny's company Billy sent Johnny a bit more than $5,000 in a single tax year but partly because Billy's lack of capacity and partly because Johnny's opportunity is other than profitable to anyone but Johnny, Billy hasn't earn a dime.

Questions: Is any part of Billy's more than $5,000 loss in any way tax deductible? Does the FTC's suit against Johnny's company need to resolve before a claim could be made? What factors would be considered in evaluation such a claim and what records must be presented to substantiate them?

Fraud and deception, sadly, seem to be growth industries. In this time of the year when thoughts turn to taxes I see questions like this popping up in places. There are a few resources to point people to relative to "investment" related fraud but it's hard to find the same for false "Biz Ops."

And the obligatory, nothing offered here is legal or tax advice. If you have personal need of legal or tax advice, please contact a qualified professional.

[Kestrel]

It would depend on the reason why Billy sent in the money.

As described, I don't see any reason why Billy couldn't deduct the $5,000 on a Schedule C as a business expense. MLM-ers do it all the time. He just can't make the loss deduction more than 2 out of every 5 years or he'll run afoul of the Hobby Loss Rule.

This will reduce his taxable income by $5,000. If he's in the lowest tax-paying bracket (15%) it will reduce his tax by $750. Got to wonder, though, whether the Billy you described (elderly, diminished capacity) would even make enough money to pay taxes in the first place.

If, however, Billy sent in that money as a contribution to Johnny's Legal Defense Fund, he can't deduct anything.

[GlimDropper]

Thank you Kestrel.

One thing I will make mention of is there is in fact a "Billy" here and while I defiantly am looking for information to share with him (his family really) I had a more general motive for this thread. I like to think I have pretty decent search skills but this is a topic I could find almost nothing written about. That probably means there is a reason for it or I just haven't found the right combination of search terms. But this place is gifted with people of relevant skills and there may be some value to future searchers to compile some information. Be that answers or just better search terms.

One (another) handicap I have coming into this is a staggering lack of knowledge of the tax code. I went from filing 1040 EZs straight to TurboTax so never have dealt with anything other than the basics. This will (only in part) explain why some of my questions are somewhat, stupid.

As to Kestrel's suggestion to deduct the loss on Schedule C, am I wrong to think Billy would have needed some sort of either incorporation or other semblage of running a business to declare a loss from running one? The instruction page for the Schedule C says:

An activity qualifies as a business if your primary purpose for engaging in the activity is for income or profit and you are involved in the activity with continuity and regularity. For example, a sporadic activity or a hobby does not qualify as a business.

While Billy has quite regularly lost money purchasing get rich quick schemes he has almost never made substantial or documentable efforts to run a "business." But his motive for paying the money was to make money, not as a donation. He gave a few hundred to a few political 501(c)(4)s for that.

I spoke with one of his family members tonight, he does have a very small federal tax liability for this year, nothing to be worried about. Filing jointly with his wife who does have some investment income in addition to pension a social they also have some rental income. From what I'm told their tax bill as it now stands looks to be "a hundred or so."

Their household income is a bit better than subsistence, no real hardship but Billy's health is in decline. I'm told there's no survivorship on his pension benefit so his wife may face issues later. The sad thing is he used to have a fairly comfortable nest egg but seems to have pissed that down one rabbit hole or another. I was acquainted with "Johnny Sleaze's" scam of a biz op for years. I knew the FTC took them to court near the end of 2012 and was hoping that because almost all the money Billy sent to them came in 2013 there might be a way to mitigate the loss.

[Kestrel]

I seriously recommend you consider seeking the advice of a qualified tax professional. Although this forum is home to both lawyers and accountants, we can not and will not give individual tax advice through an anonymous internet forum. You need someone who can examine your entire situation, in private, and give you advice specific to your circumstances. Anything else would be irresponsible malpractice.

-- No, you do not have to officially incorporate to have a small business, nor do you need a Federal Tax Identification Number for that business. Many don't.
-- When filing your tax return you need to include all your sources of income, including your receipts from working as a self-employed individual. You don't get to cherry-pick which income sources to declare.
-- Many small businesses lose money during the first one or two years, once they tally up all their start-up expenses. The business owners still have to file a Schedule C with their individual tax returns.

What I can do is direct you to information published by the IRS that will help you understand how to handle your situation:
IRS Self-Employed Individuals Tax Center
IRS Video - Schedule C: Who needs to file and how to do it
Is Your Hobby a For-Profit Endeavor?
IRS Publication 535 - Business Expenses

[Kestrel]

Filing jointly with his wife who does have some investment income in addition to pension a social they also have some rental income.

There are special rules for profits and losses from rental activity. Fortunately, Turbo Tax handles that quite well.

The sad thing is he used to have a fairly comfortable nest egg but seems to have pissed that down one rabbit hole or another. I was acquainted with "Johnny Sleaze's" scam of a biz op for years. I knew the FTC took them to court near the end of 2012 and was hoping that because almost all the money Billy sent to them came in 2013 there might be a way to mitigate the loss.

You seem to be wanting to make a deduction for theft losses. Again, documentation is essential. Whether you can make a theft deduction will depend, in part, on whether the court has made a decision. If the court has not reached a decision, or dismissed the charges, you probably have no case.

In this country, adults have the right to make stupid business decisions. They have the right to throw good money after bad, and they themselves bear the responsibility for the losses. You said Billy has a history of pursing get-rich-quick schemes. Unfortunately for Billy, in the United States the laws against such schemes are often not enforced.

Here is information from the IRS on handling theft losses from Ponzi investment schemes. Note, however, that this presumes the supposed investment scheme has been officially declared to be a Ponzi scheme theft. Very, very few multi-level marketing companies or "work from home" business opportunities in the United States have ever been declared to be Ponzi schemes.

IRS Help for Victims of Ponzi Investment Schemes
IRS Publication 547 - Casualties, Disasters, and Thefts
IRS Form 4684 - Casualties and Thefts