Ripped Off in a Financial Scam? You Might Qualify for a Tax Deduction

In the ever-evolving landscape of financial scams, victims often find themselves not only robbed of their hard-earned money but also burdened with the additional pain of tax liabilities. However, a recent legal memorandum from the IRS has brought a glimmer of hope to those who have fallen prey to such deceitful schemes. The memo, released on March 14, 2025, concludes that some scam victims can still take theft loss deductions despite the Tax Cuts and Jobs Act’s (TCJA) limitation on personal losses. This provision allows taxpayers who were cheated in their attempts to invest to take advantage of the theft loss provision for “transactions entered into for profit” and wouldn’t be limited by the TCJA’s restriction on personal casualty losses.

The memo, dated January 17, 2025 (ILM 202511015), considers five types of scams, including the notorious "pig butchering" scam, and the IRS took the position that three of the five would qualify for theft loss deductions in 2024. The criteria for qualifying for these deductions are stringent but clear. The scam must qualify as fraud or larceny under the law of the state where it occurred, the identity of the scammer must be unknown, the losses must be irreversible, and law enforcement must indicate there is little, if any, prospect of recovery. Additionally, the loss must come from a transaction seeking profit.

One of the most insidious scams highlighted in the memo is the "pig butchering" scam. In this scam, victims are tricked into spending money on a fake investment, generally involving cryptocurrency. The scam often starts like a romance scam, with fake virtual relationships, but instead of a direct request for money, the victim is told about the huge returns the scammer is making in some investment. The scammer directs the victim to a website or app that appears legitimate where the victim sees what look like investment returns, but the money is already gone. When the victim tries to access the stolen money, there may be excuses, demands for more money to pay fake tax debts, or simple radio silence. The IRS concluded that victims of pig butchering scams can take theft loss deductions because the scam involves a transaction entered into for profit.

Another scam that qualifies for theft loss deductions is the compromised account scam. In this scam, a victim receives a message from a scammer posing as a “fraud specialist” saying someone is trying to steal the taxpayer’s money. The victim is tricked into transferring retirement account and other brokerage account assets into new investment accounts controlled by the scammer. The IRS determined that victims of compromised account scams can take theft loss deductions because the scam involves a transaction entered into for profit.

The memo also specifies that victims of phishing scams can take theft loss deductions. In a phishing scam, an email from a fake “fraud protection analyst” leads to compromised computer systems and financial account logins. The scammer then takes the victim’s investment assets without further action by the victim. The IRS concluded that victims of phishing scams can take theft loss deductions because the scam involves a transaction entered into for profit.

However, not all scams qualify for theft loss deductions. The memo specifies that victims of romance scams and kidnapping scams do not qualify for these deductions. In a romance scam, the victim is involved in a fake online relationship with a scammer who asks for money for a sick relative. The victim forks over assets because of a personal relationship with whomever the scammer has impersonated. In a kidnapping scam, the perpetrator calls and pretends to hold the victim’s grandchild hostage, often using an artificial intelligence program to mimic the grandchild’s voice. The victim pays a “ransom” only to later discover there had never been a kidnapping. The IRS concluded that victims of romance and kidnapping scams cannot take theft loss deductions because these scams do not involve transactions entered into for profit.

The IRS's recent legal memorandum provides a pathway for scam victims to recover financially by allowing theft loss deductions for transactions entered into for profit. This provision offers relief to victims who have suffered significant financial losses due to fraudulent activities, helping them mitigate the additional burden of tax liabilities on their stolen funds. The memo's analysis tracks a position recently propounded by attorneys considering the possibility of tax deductions for victims of “pig butchering,” a new form of investment scam. Eric G. Lanning of Frost Law and Alyssa Maloof Whatley of the Law Offices of Alyssa Maloof Whatley both supported the IRS's analysis, indicating that the memo provides a clear outline for qualifying for theft loss deductions.

In conclusion, the IRS's recent legal memorandum on theft loss deductions for scam victims is a significant development in the financial recovery process for those who have been defrauded. The memo provides a clear pathway for victims to recover financially by allowing theft loss deductions for transactions entered into for profit. This provision offers relief to victims who have suffered significant financial losses due to fraudulent activities, helping them mitigate the additional burden of tax liabilities on their stolen funds. The memo's analysis tracks a position recently propounded by attorneys considering the possibility of tax deductions for victims of “pig butchering,” a new form of investment scam. The IRS's compassion for scam victims should help drive voluntary compliance because the agency won’t appear to be adding extra pain to those already in distress.