Americans lost over $10 billion from theft and fraud in 2023, according to a report from the Federal Trade Commission. With many of these schemes happening online, victims often turn to their tax professionals for guidance on claiming theft loss deductions. Before the Tax Cuts and Jobs Act of 2017 (TCJA), theft loss deductions were more straightforward. Victims had to prove the theft occurred, the amount lost, the discovery year, and that the loss was not reimbursed by insurance.
After the TCJA was signed into law in 2017, theft losses faced more limitations from 2018 to 2025. Section 165 of the tax code outlines the rules for deductions, with section 165(c) limiting deductions for individual taxpayers. The TCJA added a restriction for section 165(c)(3) losses, stating that they cannot be claimed unless the loss is due to a federally declared disaster. This change makes it harder for victims to claim theft loss deductions for internet-based fraud.
Despite the limitations, prior IRS guidance may offer some help. The IRS has stated that theft losses can occur under section 165(c)(1) or (c)(2) as well as (c)(3). For example, victims of a Ponzi scheme were able to claim a theft loss deduction under section 165(c)(2) if they reasonably believed they were making legitimate investments. However, beyond these rulings, there is limited authority on the deductibility of theft losses under section 165(c)(1) and (c)(2).
For victims of internet-based fraud, claiming theft loss deductions under the TCJA remains challenging. Most victims would not qualify under section 165(c)(1) as they are not in a trade or business related to the theft. Additionally, section 165(c)(3) is not applicable unless the theft is due to a federally declared disaster. This leaves victims with the possibility of fitting under section 165(c)(2), which relates to transactions entered into for profit.
Federal courts have determined that taxpayers fall under section 165(c)(2) if they entered into a transaction with the intent to profit. This decision is based on the specific facts of each case, making it difficult for victims of internet fraud to claim under this section. Romance scams, for example, would likely fall under section 165(c)(3) as the funds were transferred for personal reasons. However, scams involving investments may have a stronger argument for falling under section 165(c)(2) and potentially claiming a theft loss deduction.
In conclusion, theft losses under the TCJA are complex, especially for victims of online fraud. Consultation with a tax professional is essential for determining the possibility of claiming a theft loss deduction based on the circumstances surrounding the theft. Theft loss deductions remain a challenging area of tax law, requiring careful consideration of the specific details of each case before making a claim.
