Americans continue to lose money from fraud at alarming rates. According to a recent Federal Trade Commission (FTC) report, they reported losing more than $12.5 billion from fraud in 2025 (an increase of 25% from the prior year). The actual losses are almost certainly much higher.
In addition to the loss itself, Americans suffer from confusion concerning whether they may claim deductions as a result of the fraud. Indeed, there are a multitude of complex tax issues that arise from theft losses, such as timing and the limitations imposed on these losses after passage of the Tax Cuts and Jobs Act of 2017 (TCJA). For example, a fraud victim who withdraws funds from a taxable retirement account, losing those same funds to fraud, must wrestle with potential income recognition from the retirement account, whether the facts and circumstances support a theft loss, and, if so, the timing and character of the loss.
I’ve spoken on the federal tax consequences associated with fraud in many articles, including here and here. As a tax attorney, I started seeing a proliferation of these scams, often conducted online, during the onset of COVID-19. Unfortunately, I continue to see them today. I have counseled many clients on these issues, and IRS Chief Counsel has finally also weighed in, releasing a memorandum on March 14, 2025, that addresses some of these tax issues.
Theft Loss Deductions Generally
Theft loss deductions have always been tricky, even pre-TCJA. Generally, taxpayers could claim theft losses if they proved three requirements: (i) a theft occurred under governing law; (ii) the amount of the deductible loss, which was limited to basis in the stolen assets or funds; and (iii) the proper year to claim the loss, which was limited to when the theft was discovered and whether they had any reasonable prospect of recovery at the end of the year. Because these requirements were factually intensive, it was common for the IRS to challenge a taxpayer’s claim to a theft loss.
The TCJA raised additional hurdles to claim the deduction. Under the TCJA, taxpayers may no longer claim theft losses under section 165(c)(3) unless the taxpayer meets the qualifications under the personal casualty loss rules, including that the loss was attributable to a federally declared disaster area. In addition, the TCJA disallowed miscellaneous itemized deductions, which arguably may include some types of theft losses.
The IRS Chief Counsel Memorandum
IRS Chief Counsel issued CCM 202511015 on March 14, 2025. In the preamble to the memorandum, the agency notes that they are “aware that taxpayers have suffered from losses from various scams perpetrated by unknown individuals operating domestically and internationally.” The memorandum provides five fact patterns and IRS Chief Counsel’s interpretation of whether taxpayers in those circumstances qualify for a theft loss deduction post-TCJA. In addition, the memorandum discusses whether the five taxpayers qualify for the safe harbor under Rev. Proc. 2009-20.
Taxpayer 1 – Compromised Account
Scammer A contacted Taxpayer 1 to inform the taxpayer that he was a “fraud specialist” of Taxpayer 1’s financial institution. Scammer A convinced Taxpayer 1 that his IRA and non-IRA accounts were not secure and that he should transfer the accounts to another account established by Scammer A. After the funds were transferred, Taxpayer 1 discovers he was the victim of fraud.
The memorandum concludes that Taxpayer 1 may claim a theft loss under section 165(c)(2) because the Taxpayer entered into the fraudulent transaction with the intent to earn a profit. In addition, although Taxpayer 1 must recognize income on the IRA distribution, the taxpayer may increase the basis in the theft loss by the amount of income recognized.
Taxpayer 2 – Pig Butchering Investment Scam
Taxpayer 2 is a victim of a “pig butchering” investment scam. Specifically, Taxpayer 2 received an unsolicited email from Scammer A advertising a cryptocurrency investment opportunity. The email directed Taxpayer 2 to the website of a new platform that would invest cryptocurrency using “proprietary methods” to generate large profits. When Taxpayer 2 attempted to withdraw his investment and profits, he received an error message. Taxpayer 2 learns that the investment platform was a scam.
Similar to Taxpayer 1, the memorandum determines that Taxpayer 2 may claim a theft loss under section 165(c)(2) because Taxpayer 2 entered into the scam with a profit motive. In addition, Taxpayer 2 must recognize income from the IRA distribution, but such income recognition increases his basis in the theft loss.
Taxpayer 3 – Phishing Scam
Taxpayer 3 received an unsolicited email from Scammer A claiming that Taxpayer 3’s accounts had been compromised. Scammer A claimed to work for a financial institution where Taxpayer 3 held IRA and non-IRA funds. After convincing Taxpayer 3 to allow Scammer A access to the taxpayer’s computer, Scammer A learns of usernames and passwords associated with the IRA and non-IRA accounts. Scammer A then logs in and transfers the funds to an overseas account. Taxpayer 3 later learns of the fraud.
IRS Chief Counsel concludes that unlike Taxpayer 1 and 2, Taxpayer 3 never authorized the transfer of funds. Because of this fact, the agency determines that it must look to the stolen property to determine whether Taxpayer 3 had a profit motive under section 165(c)(2). Under the facts and circumstances, Taxpayer 3 had the requisite profit motive because the stolen property consisted of securities accounts—that is, Taxpayer 3 had established the accounts to earn a profit.
Taxpayer 4 – Romance Scam
Taxpayer 4 received an unsolicited text message from Scammer A. Scammer A and Taxpayer 4 develop a “virtual romantic relationship.” Scammer A convinced Taxpayer 4 to transfer funds from IRA and non-IRA accounts to a personal bank account under the guise that Scammer A needed the funds for a close relative’s necessary medical procedure. After the funds were transferred, Scammer A disappeared.
The memorandum concludes that Taxpayer 4 had no profit motive in transferring the funds. Instead, Taxpayer 4 voluntarily transferred the funds under false pretenses. Therefore, IRS Chief Counsel determines that Taxpayer 4 may not claim a theft loss under section 165(c)(2)—rather, the theft loss arises under section 165(c)(3). Accordingly, because the losses were not attributable to a federally declared disaster, Taxpayer 4 may not claim a theft loss post-TCJA. In addition, Taxpayer 4 must recognize income from the IRA distribution.
Taxpayer 5 – Kidnapping Scam
Scammer A contacted Taxpayer 5 by text and phone, claiming to have kidnapped Taxpayer 5’s grandchild. When Taxpayer 5 asked to speak to his grandchild, Scammer A used artificial intelligence to clone the grandchild’s voice, convincing Taxpayer 5 of the kidnapping. Upon Scammer A’s instructions, Taxpayer 5 transferred funds to an overseas account. The funds included Taxpayer 5’s IRA and non-IRA accounts. Taxpayer 5 later determined that it was a scam.
Similar to Taxpayer 4, Taxpayer 5 had no profit motive in making the transfer of IRA and non-IRA funds. Rather, Taxpayer 5 voluntarily transferred the funds to rescue his grandchild. Because Taxpayer 5 did not have a profit motive under section 165(c)(2), the memorandum concludes that Taxpayer 5 may not claim a theft loss deduction unless the theft was attributable to a federally declared disaster. Accordingly, Taxpayer 5 must recognize income from the IRA distributions and is not entitled to a theft loss.
Ponzi Scheme Safe Harbor
I’ve spoken about the Ponzi-scheme theft loss safe harbor here. IRS Chief Counsel also briefly discussed the safe harbor and its potential applicability to the five factual scenarios above. In the memorandum, the agency concludes that Taxpayers 1 through 5 are not entitled to use the safe harbor for numerous reasons, including because the fraudster in each instance is unknown, unidentified, never charged with a state or federal crime, and not the subject of a state or federal complaint (all requirements under the safe harbor).
Conclusion
Taxpayers with post-TCJA theft losses should take some solace in the IRS Chief Counsel memorandum and its apparent openness to allowing taxpayers to claim theft losses. But taxpayers should also be mindful that the memorandum is not binding precedent or authority on the IRS, and its conclusions, as stated therein, are “dependent on the taxpayer’s specific facts.” Before a taxpayer claims a theft loss, careful consideration should be given to analyzing potential IRS arguments associated with: (i) lack of a profit motive; (ii) claiming the improper year; and (iii) claiming a reasonable prospect of recovery exists.
Read the full article here
