The section of tax law that involves the clawback is commonly referred to as the mitigation section.
- A distinction can be made between clawback of profits and clawback of principal.
A clawback of profits is where you can go back, use this mitigation section, and reopen the statute and take your tax refund based upon deductions in the years that you earn that money.
In addition to profits, there is also the possibility of a clawback of principal, where trustees have the authority to force the return of both profits and principal within a specified time frame. This can result in the redistribution of funds among those who suffered losses.
The tax treatment of profits and principal is noticeably distinct.
While profits can be subjected to mitigation, meaning the statute can be reopened to claim tax refunds based on prior years’ taxes, principal deductions can only be taken in the year when the payment was made towards the investment in a Ponzi scheme. When the principal amount is returned to the trustee, usually in the final stages of the scheme, only a deduction for the principal can be claimed.
Learn more about the value of the Mitigation section in this educational video: