Douglas Shulman, IRS commissioner, told a Congressional hearing: “Beyond the toll of human suffering, the Madoff case raises numerous issues for the victims of losses from Ponzi-type investment schemes.”  He said losses from such schemes would be treated as “investment theft losses” and taxpayers can deduct all the supposed earnings on which the investor paid taxes as well as the cash invested in the scheme.

The IRS will allow a theft-loss deduction of 95 per cent of their investments, less any recoveries, including SIPC claims. Investors suing third parties can claim a 75 per cent theft-loss deduction.

Investors who put money in feeder funds would also get relief: the funds can claim theft-loss deductions and distribute them pro rata.

Meanwhile, Luxembourg said yesterday it would seek an out-of-court deal to end a legal row about money which investors lost to Mr Madoff that has hit a number of wealth management firms and that is damaging the country's reputation as a financial centre.

Some wealthy individuals lost money after having invested in Luxalpha, a Luxembourg-based fund set up at their request by Swiss bank giant UBS. The fund was holding around $1.4 billion of assets, sources familiar with the issue have told Reuters.

"I would encourage all parties involved to sit around a table and look for an extra-judiciary solution," Luxembourg Treasury Minister Luc Frieden told the news organisation.