By: A.J. Cook

The Internal Revenue Service often challenges personal theft loss deductions. It may disallow them because there was no theft or the taxpayer couldn't prove the loss.

The agency said Dr. Paul C.F. Vietzke's loss was not a theft, but a bad investment. Chris Zak and Thomas G. Patterson had wanted to start a business called Pan Protection Life Insurance Co., Inc. They persuaded Vietzke to invest, promising he couldn't lose much. Even if the company failed, it would cost only a small amount because they deposited 85 percent in escrow.

Later they said the company had a little more stock which they would let him buy. They said in two weeks it would sell for twice what he paid. He bought more stock. Later they said they planned to appoint him as corporate director and medical adviser. As further inducement, they said the other 11 directors had invested $25,000. He bought more stock, bringing his total to $25,000.

At a shareholders' meeting, after probing questions from the doctor, Zak and Patterson said only eight directors had invested $25,000. At another meeting, after additional interrogation from Vietzke, they admitted that only one other director had invested $25,000.

Unknown to the investors, while selling the stock, Zak and Patterson withdrew large amounts of corporate funds. When the Indiana Insurance Commission discovered this, it halted the stock sale.

Vietzke took a $25,000 theft deduction.

The IRS took stock of the transactions and rejected the deduction. The agency labeled this an investment, making it a capital loss. With no capital gains to offset it, tax rules limited his deduction to only $3,000 per year.

In court the judge ruled for the doctor saying this was a theft. "The IRS pictures this as a blundering, but well intentioned, attempt to conceive a corporation without benefit of statutory clergy. To the contrary, we view it as a blundering, but intentional, attempt by Zak and Patterson to increase their personal resources without benefit of law."

For a loan to be a theft, there must be fraud, deceit or trickery. Improper use of the money is not theft.

Paul Nathans asked Alfred Devendorf, an old buddy from Hartford's Choat School, to lend him some money. Then he asked for more and more. Nathans borrowings amounted to $192,290 which he said he spent on a newsstand, line of clothing and large inventory of magazines. On the next request for money, Devendorf suspected Nathans had not invested in the projects enumerated. He was calling for bail money. He'd been arrested for conspiring to smuggle into the U.S. a half-ton of marijuana.

The IRS disallowed Devendorf's theft deduction, saying it wasn't a swindle. Nathans confessed he had used the old Choat tie to choke money out of Devendorf. Still, the IRS called it a bad loan with the usual deduction limitations of a capital loss.

The Moral: When you lend money, you borrow trouble.

Another problem of obtaining a theft deduction is proving the theft. New Yorker James W. Thomas claimed a guest took $250 from his dresser drawer during a party. The IRS disallowed the deduction saying he had no proof; he hadn't even filed a police report.

Myron and Dorothy Sammons of Scottsdale, Ariz., thought they had adequate proof. They gave Joe Shearer $32,000 to buy two thoroughbred racehorses. Shearer delivered one costing $20,000 then disappeared. Even the Sammonses' lawyer couldn't find him. The IRS refused to let the deduction leave the gate, but the court galloped to the rescue. The lawyer's search proved the couple had a theft loss.

THE PLANNING TIP: Just missing property doesn't support a theft. Lost or misplaced items won't produce a deduction.

Some thefts are difficult to prove. Hopefully you will have statements from witnesses who saw the theft or police or insurance reports or clip of a newspaper account of the crime.

A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

Copyright © 1987-2001 A.J. Cook All Rights Reserved
This information is not intended for use without professional advise.
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Released 2-26-96