Earlier this year, the IRS Office of Chief Counsel released a memo (Memorandum Number 202511015) providing clarification on the deductibility of theft losses for scam victims. The memo made clear that relief is limited for taxpayers—those who can claim the deduction must meet a narrow set of criteria. The result is that many taxpayers impacted by popular scams like romance scams may not deduct the losses on their tax returns.
Scams are increasingly becoming more sophisticated and widespread. The FBI’s Internet Crime Complaint Center (IC3) received 859,532 complaints in 2024, totaling $16.6 billion, a 33% increase from 2023—the lion’s share of those complaints involved phishing and spoofing. In these common tricks, victims are tricked into providing personally identifying information or taking action. When that happens, taxpayers often suffer financial losses.
History
Casualty and theft losses have a long history in our tax system. In 1867, tax deductions were allowed for losses related to fire and shipwrecks. Three years later, the same year the Harpers Ferry Flood devastated parts of the Shenandoah, the definition was expanded to include floods. A few years later, the wording was changed to “storms.”
By the early 20th century, the deduction had changed again. In 1913, the first tax form under the new, modern tax system allowed a general deduction for “[l]osses actually sustained during the year incurred in trade or arising from fires, storms, or shipwreck, and not compensated for by insurance or otherwise.” The definition was later expanded to include “other casualty, and from theft.” However, the Tax Cuts and Jobs Act (TCJA) made another tweak: from 2018 to 2025, personal casualty and theft losses are deductible only to the extent that the losses are attributable to a federally declared disaster.
Memorandum
The recent memo doesn’t reflect a change in the law, but it does offer some clarity. A memorandum from the Office of Chief Counsel offers a legal analysis of substantive issues and can help taxpayers understand how the IRS might respond to similar questions in the future.
Memorandum Number 202511015 stresses that the theft loss deduction is still available for businesses and individuals who incur losses in transactions entered into for profit under section 165(c). There is no statutory definition of “a transaction entered into for profit.” However, courts have analyzed the phrase and determined that to meet the criteria, a primary profit motive is required. The Tax Court has applied a five-factor test focused on the taxpayer’s motive when deciding whether a transaction has been entered into primarily for profit.
The memo walks through several examples of scam-related thefts, including criminal fraud, larceny, or embezzlement. In each case, the theft met the initial theft loss deduction criteria. That means that the loss resulted from criminal conduct classified as theft under applicable state law, and the taxpayer had no reasonable prospect of recovering the stolen funds.
The piece that eluded some taxpayers in the example was the profit piece: to be deductible, the loss must have arisen from a transaction entered into for profit.
What this means is that taxpayers who were tricked as a result of a traditional investment scam may be entitled to tax relief. However, relief also applies to situations where a scammer misled taxpayers into transferring money under the false belief that they were protecting those funds. An example involves taxpayers who believe their bank accounts had been compromised, prompting them to transfer all their funds into new investment accounts. That behavior, IRS found, implies a profit motive—which makes the loss deductible.
In that instance, the amount of the loss that can be deducted is limited to the taxpayer’s basis in the property. However, if taxpayers are tricked into withdrawing funds from a tax-deferred account, they may still owe taxes, including an additional tax on early withdrawals, despite receiving no benefit from the withdrawn funds.
Taxpayers who are tricked into participating in “pig butchering” scams may also be entitled to relief. Pig butchering scams are long-haul scams. Fraudsters usually gain trust a little at a time and then encourage taxpayers to invest money in cryptocurrency or other investment opportunities. The scammers “fatten up” victims by making the investments initially look like money-makers in order to get taxpayers to put more into the scam. Then, the scammers “butcher” the victims by disappearing with their money.
Taxpayers who are victims of a phishing scam involving an impersonator may also be entitled to relief. In that kind of scheme, a scammer will try to take advantage of a taxpayer by suggesting there’s fraud and then claiming to be a fraud analyst. The taxpayer will then try to protect their assets from purported fraud by calling a number and communicating with the “fraud analyst.” Once the “fraud analyst” is able to access the taxpayer’s account, they take the money and run. The amount of the loss allowable as a deduction is limited to the taxpayer’s basis in the property.
Unfortunately, the memo also clarified that taxpayers who lose money through personal scams, such as romance or false kidnapping schemes, likely do not qualify for the deduction. The memo points to a romance scam where a taxpayer was tricked into turning over money to a fraudster. Since the taxpayers’ motives in those scams do not include investing or reinvesting funds but to voluntarily transfer them—even if it’s under false pretenses—the loss is not deductible. (There is, however, an important exception: if the scammer convinces the victim to participate in a fraudulent investment scheme for the purpose of making a profit, the loss may be deductible.)
The same analysis is true for victims of kidnapping scams. In the example outlined in the memo, the taxpayer was contacted by text and phone by a scammer who claimed to have kidnapped the taxpayer’s grandson for ransom. The taxpayer demanded to speak to his grandson and thought heard his grandson’s voice over the phone begging for help (the scammer used artificial intelligence, or AI, to clone the voice). The taxpayer paid a ransom to protect his grandson—who, he did not know, had not actually been kidnapped. Nonetheless, with no profit motive, the losses would not be deductible.
National Taxpayer Advocate
In her 2024 Annual Report to Congress, Erin Collins, the National Taxpayer Advocate (NTA), identified tax-related scams as one of the most serious problems facing taxpayers. The IRS had previously provided relief for Ponzi scheme victims, but offers no similar protection for victims of other scams.
Each year, the NTA also makes legislative recommendations to strengthen taxpayer rights and improve tax administration in what’s called the Purple Book. In the 2025 Purple Book, she offered solutions to provide relief to scam victims. Those solutions included restoring theft loss deductions to all victims (as they were pre-TCJA) and not simply renewing the restrictions under the TCJA. According to the NTA, “Scam victims shouldn’t be treated differently based on whether the scam involved a false investment or a false personal relationship.”
The relief proposed by the NTA also includes waiving early withdrawal penalties for scam victims. Under current law, withdrawals from deferred accounts before age 59½ are subject to a 10% additional tax (sometimes called an early withdrawal penalty). There are several exceptions, but scams and theft losses are not among them.