- The Washington Times - Wednesday, March 18, 2009

UPDATED:

With popular outrage erupting over Wall Street’s misdeeds, the Obama administration and Congress on Tuesday looked to the tax code to claw back bonuses given to traders at bailed-out insurance giant American International Group Inc. while softening the losses for victims of Ponzi scheme mastermind Bernard Madoff.

House Speaker Nancy Pelosi, California Democrat, and Senate Majority Leader Harry Reid, Nevada Democrat, said Congress was ready to pass within days new tax bills with confiscatory rates to reclaim virtually all of the $165 million in bonuses recently paid to executives at AIG, the beneficiary of about $170 billion in taxpayer bailout funds and a company at the center of the country’s credit crisis.

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Sen. Amy Klobuchar of Minnesota was one of 10 Democrats who signed a letter in support of an excise tax as high as 91 percent on the AIG bonuses if the firm does not “clean it up themselves.”

“We’ve got to do whatever it takes to make sure people that basically ripped off the American people weren’t able to profit from it,” Mrs. Klobuchar said. “At this point, we have to move forward or else risk losing the trust of the American people.”

Separately, victims of Madoff’s $64 billion investment fraud caught a break from an unlikely source: the Internal Revenue Service.

IRS Commissioner Douglas Shulman told the Senate Finance Committee that the tax agency had issued two rulings designed to soften the losses for the thousands of individual and institutional investors taken in by financial scams such as the one operated by Madoff.

The new guidelines, which were posted Tuesday on www.irs.gov, clarify rules to let victims of Ponzi schemes claim “investment theft losses” on their tax returns, allowing for greater deductions than can be claimed under other types of capital losses. The agency also has created a legal safe harbor where investors can claim the deduction right away, even if they eventually recover some of their funds when the Ponzi scheme is unwound.

But it was the AIG revelations that dominated the discussion in Congress. Republicans attacked the White House for allowing the bonuses in the first place, and a key Democratic lawmaker cautioned against the rush to use the tax code as a weapon of revenge. Despite the warning, lawmakers stampeded to introduce bills competing to take the toughest line on the bonuses, many of which will go to traders in the unit who pushed the company to the verge of collapse.

The anger on Capitol Hill almost certainly will make for an uncomfortable morning Wednesday for new AIG chief executive Edward Liddy, who met privately with lawmakers Tuesday ahead of an appearance before a House subcommittee.

But House Ways and Means Committee Chairman Charles B. Rangel, New York Democrat, sounded a note of caution about the rush to pass tax bills solely to punish one company.

“The tax code is not sacred, but it should have enough credibility so people can depend on it to raise revenue and not to penalize - that’s up to the courts,” Mr. Rangel said.

“It’s difficult for me to think of the tax code as a political weapon,” he said.

But that was a distinctly minority view.

Mr. Reid said that if the AIG bonus contracts are not renegotiated, Senate Finance Committee Chairman Max Baucus, Montana Democrat, was readying a bill that would impose taxes of 90 percent or more on the bonus money given to top AIG executives.

“I think where we are is in a position where these bonuses that AIG paid their employees should be returned. If not, we’ll have the opportunity in the next few days to pass legislation, which I think will pass overwhelmingly,” Mr. Reid said.

Senate Republican leaders hammered the Obama administration for not imposing tougher restrictions on bonuses and other compensation payouts to AIG even as the Treasury Department was pumping new taxpayer bailout funds into the company.

Sen. Charles E. Grassley, Iowa Republican, backed off slightly Tuesday from comments he made over the weekend suggesting that AIG executives consider the Japanese suicide ritual of hara-kiri to atone for the company’s massive losses.

Mr. Grassley, the ranking Republican on the Senate Finance Committee, said he would talk with Mr. Baucus about what the government can do to reclaim some of the AIG money.

“From my standpoint, it’s irresponsible for corporations to give bonuses at this time, when they’re sucking at the teat of the taxpayer,” he said.

After a meeting of House Democratic leaders, Mrs. Pelosi said the chambers’ main financial and tax committees had been charged with drafting a bill this week to recover “misspent” taxpayer money allocated to troubled private companies such as AIG.

“We have repeatedly called on executives at corporations that have taken our financial system to the brink of collapse with irresponsible business practices to return their bonuses and other financial rewards,” she said. “Most appallingly, while millions of Americans struggle through this economy, those who have received the largest measure of taxpayer assistance from the Treasury Department have shown no restraint.”

Although White House top economic adviser Lawrence H. Summers over the weekend denounced the AIG bonuses as an outrage, he and Treasury Secretary Timothy F. Geithner were on the defensive, facing questions of when they first learned of the bonus payouts and why they had not taken more forceful steps to rescind them.

The Associated Press reported that Mr. Obama learned of the bonuses Thursday.

Mr. Summers said the government should be careful in matters involving breaking private contracts such as compensation agreements.

But House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, said the federal government was more of an owner than a regulator of AIG, given the huge taxpayer investment to date in the company to keep it solvent.

“We own it. We need to exercise more control,” he said.

The new IRS rulings outlined by Mr. Shulman potentially would benefit victims of all Ponzi schemes such as the one perpetrated by Madoff.

In a classic Ponzi scheme, the con artist attracts investors with promises of high returns and pays off early investors with money raised from new participants.

Madoff pleaded guilty last week to charges he operated a bogus investment fund for more than a decade that generated investments and phantom profits that totaled $64 billion before the pyramid collapsed - the largest financial fraud in history. His victims included charities, pension funds, universities, Hollywood celebrities and small investors. Officials say Madoff had not made any of his claimed stock trades for more than a decade, and it is expected that his assets will cover just a fraction of the claims from about 4,800 listed investors.

One problem for victims of Ponzi schemes is determining when their losses occurred and when they can claim deductions. The IRS ruling is intended to circumvent that problem by letting filers claim the sum total of the loss in a single year, Mr. Shulman said.

Current tax law allows defrauded investors to seek refunds on taxes paid of phony income for up to three years prior to the exposure of the fraud. Democratic lawmakers in the House have introduced bills to extend the grace period for up to a decade.

The IRS rulings, by contrast, do not require Ponzi scheme victims to recalculate past losses but allow victims to deduct all but 5 percent of the accumulated loss from the theft in the year in which it is discovered.

Victims of the Madoff scandal may be able to recover up to $500,000 from the Securities Investor Protection Corp., the industry-run fund to cover losses from fraud. The IRS said that any money recovered through SIPC would reduce the size of the deduction that taxpayers could claim under the theft loss provision.

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