Second Circuit Affirms Tax Court; Couple Can't Deduct $8.2 Million Ponzi Loss

(Parker Tax Publishing December 2025)

The Second Circuit affirmed the Tax Court and held that a married couple was not entitled to a theft loss deduction as the result of a decline in the value of variable life insurance policies owned by the husband and invested in a Ponzi scheme orchestrated by Bernard Madoff. The court disagreed with the husband's argument that he possessed a sufficient property interest in the assets held in the separate financial accounts supporting the insurance policies and found that, even if that proposition was true, he had no property interest in any funds ultimately stolen by Madoff. Pascucci v. Comm'r, 2025 PTC 369 (2d Cir. 2025).

Background

On December 11, 2008, Christopher Pascucci owned, either directly or through trusts, 16 flexible premium variable life insurance policies (Policies). Seven of the Policies (which Pascucci had owned since 1997) were with Security Equity Life Insurance Co. (SELIC), and the other nine policies were with General American Life Insurance Co. (GenAm). Both GenAm and SELIC were subsequently acquired by Metropolitan Life Insurance Co. (MetLife).

The assets in the separate accounts supporting the policies were invested in a fund managed by Tremont Partners, Inc. (Tremont). Tremont invested portions of that fund in the Rye Select Broad Market Series of funds (Rye Broad funds), which in turn invested the funds in an account managed by Bernard L. Madoff Investment Securities LLC (BLMIS). In 2008, it became clear that the investment advisory business of BLMIS was a Ponzi scheme and that Tremont's investments in the Rye Broad funds were worthless.

On their 2008 tax return, Christopher and his wife claimed a Code Sec. 165 theft loss deduction of $8.2 million and requested a refund after carrying the loss back to 2005, 2006, and 2007. They claimed that the theft loss resulted from the decline in cash value of separate accounts for the variable life insurance policies after the unraveling of Madoff's Ponzi scheme. The IRS disallowed the theft loss deduction and the NOL carrybacks.

The Pascuccis appealed the IRS decision to the Tax Court, arguing that they were entitled to the theft loss deduction because they met the "sufficient nexus" standard set forth in Est. of Heller v. Comm'r, 147 T.C. 370 (2016) - in other words, Christopher had a sufficient nexus to the assets in the separate insurance policy accounts to claim a theft loss deduction. They also reasoned that they were entitled to a theft loss deduction since the Policies suffered a diminution in value because of Madoff's theft from BLMIS. The couple further relied on the Tax Court's decision in Jensen v. Comm'r, T.C. Memo. 1993-393, aff'd, 1995 PTC 528 (9th Cir. 1995), in claiming that Tremont and Rye Broad were merely middlemen through which they invested in BLMIS and thus losses associated with those investments were deductible.

In Pascucci v Comm'r, T.C. Memo. 2024-43, the Tax Court held that Christopher did not have investor control over the insurance policies and such lack of control fatally undermined his contention that he had an ownership interest sufficient to entitle him to deduct a theft loss. According to the Tax Court, the Pascuccis' situation was quite different from that in Jensen because unlike the investors in that case, the Pascuccis themselves could not have invested in Tremont on their own, without GenAm and SELIC. The Pascuccis appealed to the Second Circuit.

Code Sec. 165(c)(3) provides a deduction for losses of property not connected with a trade or business or a transaction entered into for profit if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. In Alphonso v. Comm'r, 2013 PTC 17 (2d Cir. 2013), the Second Circuit stated that in order to claim a Code Sec. 165(c)(3) deduction, a taxpayer must have a property interest in the property lost to casualty or theft. On appeal, the Pascuccis cited the Alphonso decision in arguing that Christopher possessed a sufficient property interest in funds stolen by Madoff and was thus entitled to a theft loss deduction.

Analysis

The Second Circuit affirmed the Tax Court and held that the Pascuccis were not entitled to a theft loss deduction because Christopher did not possess a sufficient property interest in the funds stolen by Madoff. The court noted that, in applying a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer has in the property. The Pascuccis, the court noted, failed to argue that the policies gave them a cognizable property interest in the assets held in the separate accounts under applicable state law. Even if Christopher possessed a sufficient property interest in the assets held in the separate accounts supporting the policies, the court found that he had no property interest in any funds ultimately stolen by Madoff.

The Second Circuit cited its decision in In Re Bernard L. Madoff Inv. Securities LLC, 708 F.3d 422 (2d Cir. 2013), where it held that limited partnership interests in funds that invested in BLMIS, including the Rye Broad funds, did not confer an ownership interest in money that those funds ultimately invested in BLMIS. Instead, the court noted, the separate accounts supporting the policies contained limited partnership interests in the Tremont fund, which in turn invested in the Rye Broad funds. The court also noted that the Tremont fund was organized under Delaware law and the Delaware Revised Uniform Limited Partnership Act states that "A partner has no interest in specific limited partnership property," which has been interpreted to preclude the attempt to equate ownership interests in a partnership with ownership of partnership property. The Second Circuit thus concluded that the Pascuccis had no property interest in the money Tremont invested in the Rye Broad funds, let alone in money Madoff ultimately stole from those funds and that the Tax Court rightly concluded that the Pascuccis could not claim a theft loss deduction.

For a discussion of the deductibility of losses from Ponzi-type investment schemes, see Parker Tax, ¶84,515.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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