More than $697 million a year in deductions for investment theft losses may have been erroneously claimed by taxpayers, according to a new government report, resulting in a revenue loss of over $41 million to the Treasury.

The report, by the Treasury Inspector General for Tax Administration, reviewed a sampling of tax returns filed for tax year 2008. The Internal Revenue Service estimated that more than 19,200 taxpayers filed returns for tax year 2008 claiming a total of more than $8 billion in property income casualty and theft loss deductions.

TIGTA conducted its review to assess the IRS’s efforts at ensuring the validity of the investment theft loss deductions claimed by taxpayers. The number of investment theft loss victims as a result of Ponzi schemes increased significantly in tax years 2008 and 2009 in the aftermath of such notorious cases as those of Bernard Madoff, Allen Stanford and others.

With the potentially large number of victims filing tax returns claiming these losses, IRS officials issued guidance to minimize both the administrative burden on the agency and the burden on the victims of Ponzi schemes.

Based on a review of a statistically valid sample of 140 electronically filed returns for tax year 2008 on which taxpayers reported an investment theft loss deduction, TIGTA estimated that 1,788 out of 2,177 taxpayers, or 82 percent, may have erroneously claimed deductions totaling more than $697 million. The potential revenue loss estimate of $41 million was conservative as it only represented electronically filed tax returns for one year, TIGTA noted.

“The IRS did a good job of addressing the tax implications of Ponzi scheme losses and providing guidance to affected taxpayers,” said TIGTA Inspector General J. Russell George in a statement. “However, our review identified that some taxpayers may be erroneously claiming investment theft loss deductions. Revenue losses associated with potentially erroneous deductions could be substantial.”

TIGTA made four recommendations in its report, including revising the Form 4684 to include specific information supporting key eligibility requirements, establishing a compliance initiative project to measure noncompliance for investment theft loss claims, and analyzing processes and historical data to determine the changes needed in the IRS’s processes and forms. IRS management agreed with TIGTA’s recommendations and said they plan to take the appropriate corrective actions.

The IRS’s response indicates that the erroneous investment theft loss claims were not simply mistakes either. “We have investigated promoters of abusive investment theft loss schemes and the taxpayers who participated in such schemes,” wrote Faris R. Fink, commissioner of the IRS’s Small Business/Self-Employed Division. “To maximize these compliance efforts, we have worked closely with other impacted IRS business units and our internal counsel.”

-- This article first appeared on Accounting Today.