Accounting
IRS gives new guidance for scam victims to deduct theft loss
The Internal Revenue Service has issued a chief counsel memorandum that offers guidance on who is eligible to take a theft loss deduction for scams. The
This is important because under the Tax Cuts and Jobs Act, personal casualty losses are limited to losses incurred in a disaster zone, according to James Creech, a director at the tax advocacy and controversy practice of Top 10 Firm Baker Tilly.
“These scams are just becoming so prevalent and there are so many variations,” he said. “And the scammers are sophisticated. Foreign organized crime is reaching in and targeting U.S. taxpayers, and the losses can be extremely damaging. But because they’re able to cast a wide net, there are a lot of taxpayers who had smaller losses as well.”
A taxpayer who suffers a smaller loss might not have the sophistication to know they could be entitled to take a theft loss deduction, or the facts and circumstances that may make it hard to fit into the Code Section 165(c)(2) profit motive exception to the TCJA limitations.
Over the past few years, Creech has been working with a number of taxpayers who suffered large, catastrophic losses where it made sense to get professional advice.
“The problem is that, especially when the money is being stolen out of retirement funds, there’s a Form 1099-R that comes out of the brokerage,” he explained. “You’ve got a lifetime of income that gets accelerated into one year, so you look like a million-dollar earner on paper but have no money. In that circumstance, it makes sense to find somebody like myself or another tax professional who could look at the facts and examine whether there was a profit motive in this loss.”
If the taxpayer is a retired schoolteacher or office worker, they might have lost $100,000 out of their 401(k) and may not even know about the loss, Creech noted.
“And they may not have the money to hire someone to prepare a memo on this as to what their intent was,” he added. “This guidance from the IRS changes that. Now there’s an ability for solo and small CPA firms to look at the losses that happen to their clients, especially losses that are on the more modest scale, and take a deduction consistent with the guidance. So it’s very helpful from a tax equity standpoint.”
“A lot of these scams start with an impersonation of a government agent or a bank officer saying your account is in jeopardy,” Creech said. “It’s either been hacked or the criminals see a fake account using your name. ‘We need you to move your assets to someplace safe, and once you’ve moved them we’ll return them to you. We’re really trying to protect your money.'”
The IRS guidance for this is the first Creech has seen address the motive head on: “When people are moving their money to keep it safe, the motive of doing that is to preserve future profits of the income, so there could be a profit motive for trying to keep your assets safe. And asset preservation has a profit motive. That portion of the guidance was enormously helpful, because it gives support for people that are the victims of those theft losses to take the deduction. It’s heartbreaking to see non-wealthy people get scammed like that — they’ve lost their money and they owe a huge tax bill. At least there’s a portion of them that deduct the loss.”
“But it’s just as heartbreaking to see those who lost their money in a scam that was not entered into for profit, such as the fake romance or the fake medical condition,” he noted. “For example, ‘I really love you and want to come to the U.S. so we can be together, but I really need some money to settle up some debts I have here.’ Or ‘I need medical treatment in order to live, but once I get treated I’ll come and we can be together.’ It’s still painful for the victims of the scam, but in these cases they don’t get the deduction because there was no profit motive.”
The sole silver lining for many is the withholding, according to Creech: “If there’s 24% stuck in withholding and if you can claim the loss deduction and get the withholding back, it makes an incredible difference. Sometimes that’s the only cash these people will have to live on for the rest of their life, because they lost everything else.”
How does one avoid becoming a victim? Make sure you have a “trusted contact.” Every brokerage account has a place on its application to name a trusted contact, noted Creech: “They are supposed to reach out to you, and say, ‘Hey James, your dad is about to wire $300,000 to China — is this legitimate?”
This allows the trusted contract to veto the transaction and check out what’s happening.
“I’ve seen so many of these scams where a trusted contact would have nipped it in the bud,” said Creech. “But because the victim didn’t complete the trusted contact section on the application, they’re out of luck. A trusted contact is a circuit breaker that allows the contact to pause the transaction until they can check the legitimacy of it.”
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