Pig Butchering, Phishing and Other Scams
The Internal Revenue Service (IRS) Office of Chief Counsel released a memo, ILM 2025-11015, that addressed five common scams affecting individual taxpayers and discussed whether or not a victim of an online scam may deduct a theft loss.
For three of the scenarios, the taxpayer has a profit motive for entering a transaction with the scammer and, therefore, the theft loss may be deducted. In the remaining two scenarios, the taxpayer provides money to the scammer without a profit motive, and the taxpayer may claim theft loss on taxes.
According to the memo, these assumptions are common to all five IRS theft loss scenarios:
- An unknown online scammer uses fraud and deception to convince a taxpayer to send money or investments to the scammer.
- The individual taxpayer enters a transaction with a scammer, and the taxpayer either has or does not have a profit motive for the transaction.
- There is a criminal theft of funds provided to the scammer perpetrated under state law.
- The year of the loss is the year in which the theft is discovered and reported by the taxpayer to both financial institutions and law enforcement.
- It is determined that there is no reasonable prospect of recovering the stolen funds or recovering them from insurance or any other sources.
- These scenarios do not meet the criteria to qualify for the Ponzi loss safe harbor in Rev. Proc. 2009-20 as modified by Rev. Proc. 2011-50.
The 5 Scenarios
Compromised Account Scam
In this scenario, the scammer impersonates someone who is helping the taxpayer to protect their accounts from unauthorized access. After building trust, the taxpayer is persuaded to authorize the transfer of funds from the falsely “compromised” account to a new account set up by the scammer. The scammer then accesses the new accounts and takes the funds.
Pig Butchering Investment Scam
Pig butchering occurs when a taxpayer is invited to participate in an investment activity that promises an enticing return. The taxpayer invests a small amount, realizes the expected income and successfully cashes out the investment. With trust in the investment established, the taxpayer soon invests another large sum, expecting a sizable income result. However, the scammer takes the second investment and disappears.
Phishing Scam
In a phishing scam, a taxpayer receives a fraudulent email that often appears to be from a trusted sender. The taxpayer clicks on links in the email and shares information that allows the scammer to access his computer. With this access, the scammer gains access to financial account information and authorization details. The scammer then uses this information to take funds from the taxpayer’s accounts.
Romance Scam
An impersonator entices the taxpayer into thinking they are helping someone they have a personal relationship with. The scammer will ask for funds for a medical need or to assist a family member. The taxpayer transfers money to the scammer, who then disappears with the funds. The taxpayer discovers that the online relationship was a deception intended to steal from them.
Kidnapping Scam
In a kidnapping scheme, a scammer convinces a taxpayer that one of their family members has been kidnapped and the only way to rescue them is to pay a ransom. The taxpayer pays the ransom to the scammer, who then disappears with the funds. The taxpayer soon realizes there was no kidnapping of a loved one.
Section 165 Theft Loss
Section 165 defines a theft loss as a criminal act that takes a person’s property. The amount of a theft loss is generally limited to the taxpayer’s basis in the property stolen.
The loss occurs in the tax year in which the loss is sustained or discovered, and the amount lost is not recoverable or covered by insurance proceeds or compensated from some other source. For individuals, Reg. §1.165-1(d)(1) identifies the situations for deducting a theft loss for tax purposes.
Tax deductions for scams are applicable when the theft loss is:
- Incurred in the taxpayer’s trade or business
- Incurred in a transaction entered into for profit
- Is a personal casualty loss
The impersonator, phishing and pig butchering scams in the first three scenarios described in the memo satisfy the criteria for a theft loss incurred in a transaction entered for profit. The last two scenarios, romance and kidnapping scams, described in the memo fall into the category of personal casualty loss.
For tax years 2018 – 2025, individual taxpayers may not deduct personal casualty losses except when the personal casualty loss is attributable to a federally declared disaster. According to the memo, taxpayers who are victims in the romance and kidnapping scams may not claim a theft loss on their returns if the losses occur in tax years prior to 2026.
Your Guide Forward
The number of online scams and the sophistication of these scams continue to grow. The guidance of this memo is helpful to taxpayers with tax reporting for thefts from at least these five recognized scams. For more information about this memo or other tax matters, please contact your Cherry Bekaert Tax Advisor.
