Circumstances of on-line scams have been rising lately. Whereas current legal guidelines and IRS steering counsel that victims can take a theft loss deduction on their revenue tax returns, it will possibly get murky when investments and cryptocurrencies are concerned. Within the case of the latter, the IRS typically caught with their place on Discover 2014-12 which states that any cryptocurrency associated losses can solely be eligible for a capital loss. Since capital losses can solely offset as much as $3,000 of abnormal revenue, it’s of restricted use to taxpayers, particularly in the event that they withdrew cash from their tax-deferred retirement accounts.
Luckily, a couple of months in the past, the IRS issued Chief Counsel Memorandum 202511015 which acknowledged that sure on-line rip-off victims can declare a theft loss as an itemized deduction. The memo gave examples of three scammed taxpayers who’re eligible to assert a theft loss linked to the manufacturing of revenue.
The primary taxpayer was the sufferer of a compromised account rip-off the place an impersonator contacted the taxpayer and instructed him that his funding account has been compromised and makes an attempt had been made to withdraw funds from the account. The impersonator instructed the taxpayer to arrange a brand new account managed by the impersonator and switch the cash there. The taxpayer licensed distribution from IRA accounts and to switch the distributed funds to the brand new account created by the scammer. After the taxpayer makes the switch, the impersonator transfers the cash to an abroad account.
The second taxpayer was a sufferer of a phishing rip-off. This taxpayer obtained an electronic mail that acknowledged that his retirement accounts have been compromised. The e-mail contained a hyperlink which might supposedly restore his account and offered a telephone quantity to a so-called fraud specialist. The taxpayer contacted the fraud specialist who then instructed the taxpayer to click on on the hyperlink. By doing so, the scammer was in a position to receive the taxpayer’s login data to his retirement accounts and used it to switch the funds to an abroad account. Whereas the info are just like the primary taxpayer, the second taxpayer didn’t authorize the scammer to switch the taxpayer’s funds to the abroad account.
The third taxpayer is a sufferer of the pig-butchering rip-off. The taxpayer was contacted by somebody on-line. After some dialog, the scammer instructed the taxpayer a couple of secret funding alternative that has better-than-market-rate returns utilizing a proprietary funding platform. The taxpayer counting on the scammer’s fee of return put in the funding platform to his telephone after which transferred cash into this platform. Quickly after transferring the cash, his account steadiness grew immensely and the taxpayer added much more cash. Sooner or later, the taxpayer tried to withdraw the cash however was unable to take action except he paid further charges or taxes to the platform. The taxpayer turned suspicious and thru an internet search discovered that the funding platform was faux.
The IRS acknowledged that the three taxpayers talked about above can take a theft loss deduction for the sum of money they misplaced. Additionally, since their theft was linked to a transaction entered into for revenue, it isn’t thought of a private theft and thus not topic to the restrictions imposed as a result of Tax Cuts and Jobs Act.
Whereas that is excellent news, those that are being audited is not going to win on this concern just by sending a duplicate of this memo to the auditor. It is because the memorandum doesn’t tackle two points that could be scrutinized by tax auditors.
The primary concern is whether or not there’s a affordable probability of restoration of the stolen funds. If there’s a probability of restoration, the theft loss can’t be claimed till one thing occurs to point out that there is no such thing as a longer an opportunity of restoration. Typically, rip-off victims have a low probability of getting their a refund, often as a result of the scammers are situated abroad. Even submitting a police report is not going to assist, particularly if the native company doesn’t have the satisfactory experience or assets.
But when a sufferer information a civil lawsuit towards the scammer and different events, akin to a financial institution or cryptocurrency change platform, it’s debatable that there’s affordable probability of restoration. Most rip-off victims having discovered their lesson don’t need to pay for a lawsuit except they’re assured to get better. And most attorneys is not going to take a case on contingency except they’re fairly sure to get better. As these lawsuits are likely to take months or years to settle, if the taxpayer has revenue from cashing out investments or retirement accounts, they could not be capable to declare the theft loss on the identical 12 months to offset that revenue.
The IRS will take a look at the info and circumstances of every case to see whether or not there’s a affordable probability to get better the stolen funds. Nonetheless, sure occasions might present potential restoration, akin to acquiring a prejudgment attachment towards the defendant’s belongings earlier than a lawsuit is concluded.
The second concern is whether or not the scammer violated the theft legal guidelines within the state the place the sufferer lived. In most states, scammers have dedicated theft by false pretenses. The weather often are 1) a false assertion made by the scammer; 2) switch of cash or property in reliance of the scammer’s false statements; and three) the scammer had the precise intent to steal from the sufferer.
Proving particular intent would be the most tough as a result of typically, the scammer is not going to admit to stealing from the sufferer. As an alternative, circumstantial proof can be wanted to show intent. This contains chat information, and within the case of pig butchering rip-off victims, screenshots of the scammer’s so-called funding platform exhibiting faux positive factors.
Contemplating the tax auditor’s perspective would possibly assist. She or he would possibly analyze whether or not the info present a theft or just a foul funding. A taxpayer who misplaced a big chunk of their funding have a propensity to argue there was a theft with a purpose to get higher tax advantages.
One remaining notice concerning the IRS memo is that it doesn’t tackle those that misplaced cash on account of cryptocurrency failures (such because the Luna Stablecoin) and exchanges which have gone bankrupt akin to FTX, Celsius, Three Arrows Capital, and Mt. Gox, to call a couple of. A few of the masterminds of those organizations have arguably dedicated theft through the use of buyer deposit funds for lavish private bills or to pay early buyers.
This latest IRS steering ought to make taxpayers really feel extra comfy about taking the theft loss deduction as long as the necessities are met. Nonetheless, claiming a big loss can improve their probability of an audit and taxpayers might want to present greater than a duplicate of this memo to show their case.
On June 26, 2025, in coordination with Operation Shamrock, I can be giving a presentation explaining easy methods to declare the theft loss and easy methods to mitigate the tax penalties of withdrawing from funding and tax-deferred accounts on account of scams. Operation Shamrock’s aim is to teach the general public, mobilize collective motion, and disrupt the operations networks of transnational organized criminals to forestall additional hurt. Please electronic mail me for extra particulars.
Steven Chung is a tax legal professional in Los Angeles, California. He helps individuals with fundamental tax planning and resolve tax disputes. He’s additionally sympathetic to individuals with giant pupil loans. He may be reached by way of electronic mail at [email protected]. Or you may join with him on Twitter (@stevenchung) and join with him on LinkedIn.
