San Diego Estate Planning Lawyer Blog
Bernard Madoff ran one of the largest Ponzi schemes in history. Madoff ran his own brokerage firm for nearly 50 years, claiming unusually high returns on investments. In reality, Madoff’s company stopped trading in stocks in the early 1990s. Instead, he simply used money provided by new clients to pay off fabricated returns to existing customers. In late 2008, in the midst of a credit crunch, Madoff’s scheme collapsed, leaving roughly 4,800 clients holding $65 billion in phantom assets.
The estates of some of these now-deceased former clients now face unusual probate issues. An estate must always take inventory of a deceased person’s assets and determine the date-of-death value for tax and probate purposes. But how does one value an investment based on a lie? The Internal Revenue Service and several estates are presently struggling to answer that question.
Estate of Kessel
Bernard Kessel was a Madoff client. In 1982, Kessel established a pension fund with himself as sole beneficiary. Kessel initially invested about $600,000 with Madoff.
Kessel died in July 2006, about two-and-a-half years before the Madoff scheme collapsed. Iris Steel, Kessel’s longtime partner, was named executor of his estate. As is standard procedure in an estate administration, Steel asked Madoff’s company for a list and valuation of all assets held in Kessel’s account. Based on the information provided, an appraiser hired by Steel valued the Madoff account at approximately $4.8 million at the date of Kessel’s death.
Of course, as everyone subsequently learned, the assets in the Madoff account were an elaborate lie. In fact, Steel and Kessel’s son-the beneficiaries of the account-actually withdrew more money from Madoff’s scheme than had been deposited.
This created an estate tax problem. The estate had previously paid federal estate taxes based on the appraised value of the Madoff account. After the scheme’s collapse, the estate asked the IRS for a $1.9 million refund based on its view that the appraised value of the Madoff account was now zero. The IRS rejected that argument and the estate appealed to the United States Tax Court.
On May 21 of this year, the Tax Court ruled the estate could proceed with its case. Rejecting an IRS motion for summary judgment, the court found there was a genuine dispute over the value of the Madoff account. The IRS argued the original valuation of $4.8 million was correct because it reflected the “fair market value” of the account at the time of Kessel’s death. The IRS said that a reasonable buyer would not have been aware of the fact the account was part of a Ponzi scheme. The estate argued that a buyer exercising due diligence could have uncovered Madoff’s chicanery. However the Tax Court ultimately resolves this case, it will affect not just Kessel but other Madoff investors who lost money.
In effect, the IRS wants estates to pay taxes on assets that never existed in the first place. And while the federal estate tax only affects a small percentage of estates, such aggressive activity only highlights the importance of careful estate planning. If you need advice on any estate planning matter, contact the Law Office of Scott C. Soady in San Diego today.