Victims of sophisticated online scams are often dealt a double whammy. Not only is their money forever gone, but these stolen sums often generate giant tax bills when the funds are emptied from taxable retirement accounts.
Many of these victims are often left wondering what sort of recourse they might have. Tax regulators recently provided some answers, clearing the way for more victims to seek a tax break on more solid footing.
In a memorandum released on March 14, the Internal Revenue Service’s Office of Chief Counsel described which types of scams might qualify for tax relief, which included many investment schemes and some types of impersonation fraud. But it still excludes victims of other widespread digital crimes, including kidnapping schemes, for example, and romance-related fraud that did not involve investing.
“We are aware that taxpayers have suffered losses from various scams perpetrated by unknown individuals operating domestically and internationally,” the memo said. “However, the actual scam may vary, and the application of this advice is dependent on the taxpayer’s specific facts.”
There used to be a more equitable way for people with the largest fraud losses to deduct them from their income, using a tax deduction for victims of personal casualties, disasters and theft. But that and many other individual breaks were eliminated or narrowed as part of the Republican-led tax overhaul known as the Tax Cuts and Jobs Act of 2017, which helped to pay for broader tax cuts, including a reduced corporate tax rate.
The current structure of the deduction, effective from 2018 through 2025, treats victims unevenly. It can be used only in certain situations, even though many of these fraudsters are operating out of the same playbook.
The tax deduction, in its pared down form, says that personal casualty and theft losses can be claimed only in situations like federally declared disasters or “transactions entered into for profit.”
That means deductibility is an option only if the victims had a goal of profiting when they entered into transactions with scammers — but that definition wasn’t etched into the law. The new guidance provides taxpayers with parameters by laying out several different situations that qualify and a couple that don’t.
This includes taxpayers deceived by impersonators who claim to be fraud specialists at the victim’s financial institution, who then urge them to move their money to safer accounts because their existing ones have been compromised.
Since the victim intended to safeguard and later reinvest the money, the I.R.S. deems this “a transaction entered into for profit.” In other words, the guidance recognizes that the preservation of the assets qualifies as a profit motive (and is eligible for tax deduction).
“That opens the door a bit for more taxpayers to take theft loss deductions,” said James Creech, a director at the tax advocacy and controversy practice at Baker Tilly, a large accounting and advisory firm in San Francisco. “Practically what this means is that if you are audited you can take the memo, show it to the auditor, and most likely that will resolve the question of if the transaction was entered into for profit.”
Other qualifying situations include so-called pig butchering investment schemes, where unsuspecting people are directed to seemingly legitimate mobile apps or websites where they can buy cryptocurrencies and have the opportunity to earn large profits. As their account value increases, they invest more money — but when they try to cash out, the money vanishes. This, too, is deemed a profit-driven transaction by the I.R.S.
In another situation, the taxpayer gets a phishing email from an impersonator, urging them to call a fraud analyst to ensure their money is safeguarded; the impersonator instructs the victim to click on a link in an email, which gives them control over their computer, and eventually enables them to empty the victim’s investment account without their permission.
In all three cases, the taxpayer had contacted their financial institutions and law enforcement and were informed they had little to no chance of recovering the money.
The memo also outlines scenarios that would not qualify, in large part because there is no profit motive. So if an individual was deceived into paying medical bills for a scammer posing as a romantic interest, that would not be eligible for the tax deduction. The same goes for victims who sent ransom money to criminals who had claimed to have kidnapped their grandchild using artificial intelligence to clone the child’s voice.
The guidance also clarifies that none of these situations would be eligible for the tax breaks provided to victims of Ponzi schemes, which can be used when an investment fraud meets certain conditions.
Regardless of your specific situation, it helps to document everything as soon as you realize you’ve been victimized. File a police report with local officials and federal ones, including the Federal Bureau of Investigation’s Internet Crime Complaint Center. Take screenshots of any online platforms or apps that you used to communicate with the criminals, including online conversations, photos or anything related. Create a timeline or narrative of the events.
The casualty and theft loss deduction is set to revert to its original form at the end of this year if the sweeping 2017 tax law expires. But Republicans are trying to extend that package.
The original federal casualty loss deduction was limited in different ways. It could be claimed only by taxpayers who itemized deductions on their returns, which means the total amount of those deductions had to exceed the standard deduction for it to be worth it. And the deduction applied only to losses that exceeded 10 percent of their adjusted gross income.
Lawmakers, including Representative Jamie Raskin, Democrat of Maryland, have drafted legislation to offer more comprehensive and retroactive relief, dating back to 2018 when the deduction was curtailed. But that hasn’t been passed into law.
“This I.R.S. guidance provides a good deal of clarity and relief to a lot of scam victims, including a constituent of mine who would have owed hundreds of thousands of dollars in taxes,” Mr. Raskin said in a statement. “But we still have important bipartisan work to do in Congress to make the tax code fairer for all scam victims.”
The way the states treat these situations can amplify victims’ federal losses too, tax experts said, generating significant tax liabilities of their own. But some states are trying to address that.
Joseph Vogel, a Democratic state legislator in Maryland, said he recently introduced a bill with bipartisan support that would make these losses generally deductible at the state level.
“The scams are getting better and better,” he said. “These people need some relief.”
