Bernard Madoff’s fraud might have been detected with enough due diligence in mid-2006, more than two years before the Ponzi scheme collapsed, a U.S. Tax Court judge ruled.

That means it’s possible, Judge Diane Kroupa said, that the estate of a New York man who died that year is entitled to a $1.9 million refund for death taxes paid on his $4.8 million Madoff account -- an account revealed to be worthless after the fraud was uncovered.

Kroupa, in a decision May 21, didn’t assess the likelihood that Bernard Kessel’s estate can prove its case. She did say, though, that it can try to do so at a Tax Court trial where lawyers may iron out a new wrinkle in the financial mess created by Madoff’s crimes. Other challenges to estate taxes on Madoff accounts are under administrative appeal at the IRS, Stephen Krass, a New York attorney representing the estate.

“I know there are others. How many, I don’t know,” he said, adding that the Kessel case has advanced the furthest.

The Internal Revenue Service, which rejected the estate’s bid for a refund, contended that when Kessel died in July 2006 his Madoff account was worth the $4.8 million that was reported at the time and subject to federal estate tax. A Ponzi scheme by nature remains hidden until it’s discovered or collapses, the agency argued.

The estate of Kessel, who became a customer of Bernard L. Madoff Investment Securities LLC in 1992 through a pension plan set up by a company he owned, took a different view. The value of the account was established through an appraisal. Had the estate used the more rigorous standard of fair-market value, a hypothetical buyer might have conducted due diligence that uncovered the fraud, Krass said.

Stock Certificates

Such steps might include trying to examine stock certificates for securities only to find they didn’t exist, Krass said.

Kroupa said Krass’s argument raised “disputed material facts” that merited a trial.

While the IRS said prospective buyers of Kessel’s account wouldn’t “reasonably know or foresee” that Madoff was operating a Ponzi scheme, making the account worthless, Kroupa said that wasn’t necessarily so.