Bad News for Victims : IRS May Come First for Dominelli Cash

If the Internal Revenue Service (IRS) attempts to recover the $10.4 million owed in 1982 federal income tax by J. David (Jerry) Dominelli, the government’s claim could take priority over claims by former investors of bankrupt J. David & Co., according to the trustee in charge of the fallen La Jolla investment firm.

In what could become one of the more bitter episodes in the complicated J. David & Co. saga, trustee Louis Metzger said in a letter mailed Friday to 3,100 former J. David investors and creditors that although the IRS has not yet inquired about the back taxes, any government claim “may assume a priority over other claims.”

Dominelli last month pleaded guilty to four federal felony counts--three of fraud and one of tax evasion. He admitted that he lied about his 1982 taxes when he reported only $294,507 in taxable income and paid only $329,922 in federal taxes, which included special tax categories such as capital gains.

His taxable income that year, however, was a whopping $21.6 million, on which he owed about $10.7 million. But that “income” was actually some of the money poured into J. David by investors who had been lured by promises of 40% annual returns.

The IRS will “pursue collection of anyone who owes taxes,” according to spokeswoman Nancy Dixon. “A bankruptcy doesn’t eliminate the tax debt, although it can suspend it” until the bankruptcy is completed, she said.

Dominelli, who faces 20 years in federal prison when he is sentenced June 24, has admitted that he squandered $80 million of the $200 million invested by 1,500 clients between 1979 and Feb. 13, 1984, when a group of disgruntled investors forced him and his firm into bankruptcy.

The lost money does not include the “paper” profits that investors thought were being made for them by Dominelli’s foreign currency trading.

Metzger has recouped about $11.4 million from selling various J. David assets, and an additional $5.3 million is expected to be added soon. After paying off mortgages, legal and administrative fees, the estate will net less than $10 million.

Still uncertain is the status of more than $25 million in preference payments--those funds paid to investors in the 90 days prior to the bankruptcy. Those funds legally must be returned to the estate, although most investors have balked at the trustee’s demands. To date, less than $3 million in preference payments has been recovered, and Metzger said he plans to sue for the balance.

So, under a best-case scenario, the trustee may retrieve more than $30 million. And the IRS claim, if exercised, could take a significant bite out of funds that otherwise would be returned to investors.

Metzger was anything but optimistic in his letter, telling investors and creditors that there is little “likelihood that a majority of the lost funds will be recovered.” Coincidentally, the letter was mailed one year to the day after it was discovered that Dominelli had fled to the island of Montserrat to avoid certain imprisonment for failing to cooperate with Metzger.

To emphasize his point, Metzger included in his mailing Dominelli’s 13-page admission filed in federal court last month. In the statement, Dominelli admitted that he commingled and misused investors’ funds for his personal use, that he fashioned a complicated business empire to prevent anyone from tracing his assets, that he lied about his track record as a successful money trader, that he fabricated client statements to show bogus profits, and that he needed new investor funds to pay off existing clients--all elements of a typical Ponzi scheme.