IRS Taxes Scam Victims

Losing money to a scam artist, the only criminal we refer to as an artist, is bad enough, but unfortunately, many people who have been scammed later learn that, in many instances, the IRS will not allow the scam victim to take a theft loss on his or her income tax return. In some instances, the IRS actually will assess taxes and sometimes penalties on money that scam victims lose to scammers.

Prior to the enactment of the Tax Cuts and Jobs Act (TCJA) that became effective in 2018 all victims of scams were able to take a casualty and theft loss deduction through IRC Section 165, however, the TCJA drastically limited the ability of many scam victims to take that deduction.

Making matters worse, when scammers convince their victims to take money out of their retirement accounts the repercussions go beyond merely not being able to take the loss as a theft tax deduction on their tax return because the IRS will tax the withdrawal from the account and, adding insult to injury, if the scam victim was under the age of 59 ½ when taking the money out of the retirement account to pay a scammer, the IRS assesses an additional 10% penalty for early withdrawal.

While the theft loss deduction may still be available for scams such as phony investment scams where the scam involved a bogus investment such as a scam cryptocurrency investment or scams in which the scammer convinces the victim to transfer funds from their existing accounts to accounts controlled by the scammer by telling them that their accounts had been compromised, victims of the following scams are not able to deduct their losses:

1. Romance scams in which the scammer through dating sites or social media contacts their victim and convinces the targeted victim that they are in love with them and once they have established trust, manipulate the scam victim into sending money for a variety of emergency needs. Deepfakes and AI have made this scam more realistic.
2. Phony kidnapping scams in which the victims are contacted by phone and convinced that a family member has been kidnapped. The scammers threaten harm to the family member unless a ransom is paid. Again, AI and voice cloning have made this scam more believable.
3. Tech support scams where pop-ups appear on the victim’s computer telling them that their computer has been hacked and are convinced into paying exorbitant amounts for phony tech support services to remedy the situation. This scam inordinately affects older Americans.
4. The grandparent scam or family emergency scam where the targeted victim receives a call late at night purportedly from a family member who is experiencing an emergency and needs funds to be sent right away. This scam too has become much more effective for scammers using AI, deepfakes and voice cloning.

In March of this year the IRS issued a memorandum offering guidance as to which scams qualified for the theft loss deduction.

Bills were proposed in the House and Senate last year to bring tax relief to scam victims who no longer qualify under the present tax law to take a theft law deduction. Both of those bills would have not only restored the theft loss deduction for scam victims who presently cannot deduct their losses but also would have been retroactive to any scam victims who were not able to deduct their losses since the TCJA went into effect in 2018. Unfortunately, both bills died in committee.

The good news is that if Congress does not act to extend the TCJA provisions, the pre 2018 rules would go back into effect in 2026 and allow future scam victims to deduct their losses, however, this would not provide any help to scam victims who lost money to scams between 2018 and 2025 and it is also possible that the TCJA provisions limiting the rights of scam victims will be extended by Congress.

The Taxpayer Advocate Service is an independent organization within the IRS that assists taxpayers in resolving problems with the IRS and also makes recommendations for tax law changes to Congress. In its 2024 Annual Report to Congress the Taxpayer Advocate Services identified tax-related scams as one of the most serious problems facing taxpayers. In a memo issued last April, they recommended Congress allow the TCJA restriction to expire and thereby restore the broader theft loss deduction. They also recommended that Congress make the change retroactive to cover theft losses sustained by scam victims between 2018 and 2025.