IRS Clarifies Theft Loss Deductions for Scam Victims Amid Rising Fraud Risks
From the Desk of Jim Eccleston at Eccleston Law
The IRS has issued new guidance clarifying when victims of financial scams can claim theft loss deductions on their taxes. According to Financial Planning, the guidance offers much-needed direction amid increasingly sophisticated fraud schemes targeting consumers.
In a memo from the IRS Office of Chief Counsel, the agency confirmed that victims may generally deduct the tax basis of their losses in the year they discover the theft, provided the motive behind moving their funds was for investment purposes. As reported by Financial Planning, this clarification resolves longstanding uncertainty over whether such transactions qualify as “entered into for profit” or are merely personal casualty losses, which the Tax Cuts and Jobs Act restricted to federally declared disaster areas.
The IRS memo presented five common scam scenarios, including compromised accounts, phishing schemes, and so-called “pig butchering” scams. It determined that victims in these cases could deduct their tax basis, typically their initial investment, excluding any unrealized gains provided they intended to protect or reinvest their funds. Conversely, victims of romance scams and kidnapping scams do not qualify, as these losses lack a profit motive and instead fall under disallowed personal casualty losses.
Further, the memo reaffirmed that early withdrawals from individual retirement accounts (IRAs) used in fraudulent transactions remain subject to standard penalties. It also distinguished these scams from Ponzi schemes, which carry unique tax deduction rules if certain criminal charges and operational criteria are met. Financial Planning reports that none of the examples in the memo qualified under the Ponzi scheme framework.
The memo’s limitations did not go unnoticed. National Taxpayer Advocate Erin Collins welcomed the IRS’ clarification but pointed out remaining gaps in taxpayer protections. According to Financial Planning, Collins urged lawmakers to lift restrictions on theft loss deductions, extend the statute of limitations for refund claims, waive early withdrawal penalties for scam victims, and permit taxpayers to amend prior returns for losses sustained.
While these proposals face uncertain prospects in Congress, especially with the pending review of 2017 tax law provisions, the memo still marks a crucial step toward clearer, fairer tax treatment for scam victims. Tax advisors and financial professionals now have firmer footing to help clients manage losses and implement fraud prevention strategies in a digital environment where financial deception has become alarmingly routine.
Eccleston Law LLC represents investors and financial advisors nationwide in securities, employment, transition, regulatory, and disciplinary matters.
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