In 2001, Rocky and Bullwinkle (R&B) (MFJ) invested the sum of $250,000 with Boris Badenov, who held himself out to the public as an investment and securities broker. R&B gave Badenov a power of attorney to use the $250,000 sum to buy and sell securities on their behalf. Any income or gains on this initial investment were to be reinvested. In 2002, R&B contributed an additional $50,000, in 2003 an additional $40,000 and in 2004 they contributed an additional $10,000. Badenov periodically issued account statements to R&B that reported the securities purchases, sales, and re-investments that Badenov purportedly made in their investment account. He also issued tax forms and statements to R&B and to the IRS that reflected purported gains and losses on their investment account. Badenov reported to R&B and the IRS that income in 2001 was $25,000, $35,000 in 2002, $65,000 in 2003, in $75,000 in 2004 and $80,000 for each of the years 2005 2007. R&B included all of these amounts in their federal gross income on their annual income tax returns. R&B took distributions of $25,000 for each of the years 2003 through 2006 in order to pay for their daughters college education. No other distributions were made from the account.

In 2008 it was discovered that Badenovs purported investment advisory and brokerage activity was in fact a fraudulent Ponzi scheme, and that his reported investment activities and the resulting income amounts for his investors were partially or wholly fictitious. When Badenovs fraud was discovered in 2008, he had only a small fraction of the funds that he reported on his investors account balances. As a result, investors would never receive the amount in their account balance, and would receive no reimbursement or other recovery for the loss these funds. Badenovs actions constituted criminal fraud or embezzlement under the laws of the state. R&B had no knowledge that Badenovs activities were a fraudulent scheme. Tax years 2001 through 2004 are closed for R&B (the statute of limitations being three years for their federal income tax returns), but years 2005 through 2007 were still open.

Refer to Revenue Ruling 2009-9 and Revenue Procedure 2009-20. Check the dates of promulgation for each of these documents to check the ordering and predominance. Find very helpful step-by-step calculation instructions in Revenue Procedure 2009-20.

Based on the information provided therein, analyze the above fact pattern and respond to the following questions:

Issues:

1. What is the character of Rockys and Bullwinkles loss? Under what IRC Code Section?

2. What amount is deductible to R&B?

3. What year(s) may R&B take such deductions?

Assignment:

Prepare a tax memorandum, using the Bull & Bear template, addressing this fact pattern. Determine the character, amount and timing of any losses that Rocky and Bullwinkle are permitted to take. The memorandum should be no more than three single-spaced pages long. BE SURE TO INCLUDE AN EXCEL SPREADSHEET CALCULATING THE DEDUCTION AND EMBED IN THE MEMO.