IRS Provides Critical Relief for Victims of Online Scams, But Only Some Qualify

By Luke Ryan  |  May 2025

In a significant development for taxpayers ensnared by increasingly sophisticated online scams, the Internal Revenue Service (IRS) has issued new guidance clarifying when losses from such frauds may be deductible under the tax code.  The memorandum, Chief Counsel Advice 202511015, offers new hope to victims—particularly those defrauded in schemes involving the misappropriation of retirement or investment account funds—by recognizing their losses as potentially deductible theft losses under Internal Revenue Code​ (IRC) § 165.

I.                    Background:  The “Double Whammy” of Scam Victimization

Victims of online financial scams often suffer a "double whammy": not only do they lose their money, but they can also face significant tax liabilities, particularly when scammers coerce or trick them into liquidating retirement accounts.  Such distributions are typically treated as taxable income, even if the funds are stolen before the taxpayer benefits from them​.

Prior to the IRS’s recent guidance, victims were left in legal limbo.  While IRC § 165 allows taxpayers to deduct theft losses, the scope of eligible losses narrowed significantly following the 2017 Tax Cuts and Jobs Act (TCJA).  The TCJA restricted personal casualty and theft loss deductions to those arising from federally declared disasters or transactions entered into for profit—terms not clearly defined in the statute.

II.                  The New Chief Counsel Memo Offers Critical Clarifications On Several Key Issues

a.      Losses Are Deductible If Tied to Profit-Seeking Activity

Victims may deduct scam-related losses if the transaction originated from an intent to generate profit.  For example, taxpayers deceived into transferring funds to fake investment platforms or who were tricked into moving retirement funds under the guise of "protecting" their accounts fall within this category​.

b.      Losses Must Be Unrecoverable

To be deductible, the loss must be “sustained” under § 165—meaning the taxpayer must have discovered the loss and determined that there is no reasonable prospect of recovery.  This often involves a police report, confirmation from financial institutions, and documentation of efforts to recover the funds​.

c.      Examples of Deductible Scams

Under the IRS’s new guidance, examples of deductible scams are the following:

·       Compromised Account Scams:  Impersonators posing as fraud specialists who direct victims to transfer funds to fake “safe” accounts.

·       Pig Butchering Schemes:  Victims are lured into fraudulent investment platforms, often involving cryptocurrency, and encouraged to invest larger sums over time before their money vanishes.

·       Phishing Attacks:  Scammers gain access to victims’ accounts through malicious links or spyware and then transfer the funds without authorization.

In each of these cases, the IRS deemed the victims' actions as profit-motivated, thus meeting the deductibility threshold under § 165(c)(2)​.

d.      Non-Deductible Scenarios

In the following situations, the loss of the funds is not deductible:

·       Romance Scams:  Where funds were given to scammers under false emotional pretenses (e.g., paying fictitious medical bills) because no profit motive was present.

·       Kidnapping Hoaxes:  Victims coerced into transferring money under false threats (e.g., AI-generated voice cloning) do not qualify because these are considered personal casualty losses that are currently disallowed unless tied to federally declared disasters​.

e.      Ponzi Scheme Safe Harbor Not Applicable

The IRS reiterated that losses from Ponzi scams do not qualify under the Ponzi safe harbor, Rev. Proc. 2009-20, which requires the fraudster to be formally indicted or charged.  In many scam cases, the perpetrators remain unidentified​.

III.                Why This Matters

The IRS’s recent memorandum provides a clear legal foundation for many scam victims to claim theft loss deductions where previously there was uncertainty.  The guidance allows affected taxpayers to present a stronger case during audits, citing the IRS’s own interpretive framework to support their deductions​.

Importantly, the IRS distinguishes between scams that share superficial similarities but differ legally in their deductibility.  The IRS's recognition of intent to preserve or grow assets as a profit motive represents a significant taxpayer-friendly interpretation that expands access to relief for those who suffered legitimate economic harm.

IV.               Limitations and Legislative Outlook

The relief remains constrained by the TCJA’s broader restrictions.  Personal theft losses without a profit motive—no matter how compelling the story—remain nondeductible through 2025 unless the law changes.  Lawmakers, including Rep. Jamie Raskin, have proposed legislation to restore broader theft loss deductions retroactively to 2018, but such reforms have yet to pass​.

Some states, like Maryland, are also considering legislative fixes to allow victims to deduct scam losses at the state level, providing an additional path to relief​.

V.                  Conclusion

The IRS’s new guidance marks a crucial step forward in addressing the financial fallout from the explosion of digital fraud.  While not a panacea for all scam victims, it does offer meaningful relief for many who acted in good faith, believed they were investing, and now face serious tax consequences from those deceptions.  For these taxpayers, documentation, timing, and the nature of the transaction are essential.

In addition, tax professionals should encourage clients who have suffered scam-related losses to gather documentation promptly, file police and fraud reports, and consult a tax advisor to determine eligibility under § 165.