Too Good to Be True ... Ask TaxMama ... May 9, 2004

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Tax Information With A Mother's Touch

Published by Eva Rosenberg, MBA, EA
Volume 6, Issue 257 May 9, 2004


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Too Good to Be True

» From: Douglasville, GA

Dear TaxMama:

I invested in an untraditional investment program online and wanted your opinion on the tax liability.

Here's the basics of the program:

The program is based on units. Each unit cost $25 and pays 2% interest every business day for 120 days and then the unit expires.

For example:

I invested $5,000. That bought me 200 units at $25 each. The 200 units pay me a total of $100 a day in interest and will do so for 120 days which will pay $12,000 in return. That results in a $7,000 profit.

The way the program is structured I do not get my principal back in a lump sum but it is paid back over the first 50 days as a part of the daily 2% interest payout.

Here's the tricky part. I am reinvesting 50% of my daily earnings to purchase more units everyday. That creates an ongoing monthly income because even though my units expire, I am constantly purchasing new ones.

For example, I earn $100 a day in interest. I withdraw $50 and I reinvest $50. That buys me two additional units everyday.

Here is my tax question. Do I owe taxes on the whole $100 I earn daily? Or just $50 since I reinvest $50 daily and withdraw $50?

Key fact:

I do not get my principal back in a lump sum. So the $5000 I invested is only paid back to me by the daily interest I receive. So the first 50 days of the 120 day term pays me back my principal.

So since I have no control over my principal and cannot withdraw it in a lump sum, its really like I am buying a 120 day annuity or income stream.

How would you assess the tax liability on the scenario I presented.

Charles

Dear Charles,

Incredible returns!

And I mean, incredible.

EVERY time I come across something like this, it turns out to be a Ponzi scheme.

In fact, the whole stock theft loss article research came about because of something that looked just like this one does.

There is NO reasonable way to generate the kinds of returns you're getting in today's market. The company is probably using the funds of new members and your reinvestment money to pay the returns.

After this cycle of repayments on your present investments is completed, stop. Don't reinvest anymore. It WILL collapse soon.

The couple who started our research into theft loss lost $700,000 by the time is was done.

That said, the portion that is taxable is the interest only. Essentially, if you're getting back 'principal' over the life of the repayment. That means you're getting $41.67 per day in principal on a $5,000 investments. The rest is interest.

ALL the interest you earn each day is taxable.

The fact that you choose to reinvest it doesn't enter into the calculation. Treat each reinvestment as a whole separate investment.

If this were a legitimate investment, they would provide 1099s for the earnings so you would not have to perform these calculations at all. At the very least, they would provide an amortization calculator for their members.

I know it feels amazing to get this kind of return when everyone else is moaning about 1-2% per year. But, please, please, know when to fold 'em. And know when to run.

Best wishes,

Eva Rosenberg
Your TaxMama

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