In 2011, Robert and Bella (R&B) who are married filing jointly (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 2012, R&B contributed an additional $50,000, in 2013 an additional $40,000 and in 2014 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 2011 was $25,000, $35,000 in 2012, $65,000 in 2013, in $75,000 in 2014 and $80,000 for each of the years 2015 2017. 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 2013 through 2016 in order to pay for their daughters college education. No other distributions were made from the account.

In 2018 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 2018, 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 of these funds. Badenovs actions constituted criminal fraud or embezzlement under the laws of their state. R&B had no prior knowledge that Badenovs activities were a fraudulent scheme. Tax years 2011 through 2014 are closed for R&B (the statute of limitations being three years for their federal income tax returns), but years 2015 through 2017 were still open.

What would be their actual recovery according to Standard Federal Tax Reported (2020) 10,101.026, Theft and Embezzlement: Losses from Ponzi Schemes. IRC 165, Regs. 1.165-8, Revenue Ruling 2009-9 and Revenue Procedure 2009-20