Phishing, Pig Butchering and Other Scams
The Internal Revenue Service’s Office of Chief Counsel issued a memo, ILM 2025-1115 that discussed five scams that affect individual taxpayers. It also addressed whether or not the victim of a scam online can deduct their theft loss.
In three scenarios, there is a profit motive on the part of the taxpayer for engaging in a transaction with a scammer. The theft loss can be deducted. In the two remaining scenarios, taxpayers provide money to scammers without any profit motive. They can claim theft losses on their taxes.
The memo states that these assumptions are the same for all five IRS theft loss scenarios.
- Unknown online scammers use fraud and deception in order to convince taxpayers to send them money or invest with 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.
- A criminal act of theft is committed 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 Five Scenarios
- Compromised Account Scam
In this case, the scammer pretends to be someone helping the taxpayer protect their account from unauthorised access. After building trust with the taxpayer, the scammer convinces him to transfer funds from a falsely “compromised account” to a newly created account. The scammer accesses these new accounts and steals the money.
- Pig Butchering Investment Scam
Pig butchering is when a taxpayer agrees to take part in a lucrative investment that promises enticing returns. The taxpayer invests in a small sum, receives the income expected and is able to cash out their investment. The taxpayer, now confident in his investment, invests a large amount, expecting to see a significant income. The scammer, however, takes the second investment and disappears.
3. Phishing Scam
In a phishing scheme, a taxpayer receives an email from a scammer that appears to come from a trustworthy sender. The taxpayer clicks links and gives information to the scammer. The scammer can then access the taxpayer’s financial account details and authorization details. This information is then used by the scammer to steal money from the account of a taxpayer.
4. Romance Scam
Impersonators trick taxpayers into believing they are helping a person with whom they have a close relationship. The scammer may ask for money to help a family member or for medical needs. The scammer takes the money from the taxpayer and disappears. The taxpayer learns that their online relationship was an elaborate ruse to steal money from them.
5. 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.
The following scams qualify for tax deductions:
- Incurred in the taxpayer’s trade or business
- Incurred in a transaction entered into for profit
- Is a personal casualty loss
The first three scenarios in the memo, impersonator scams, phishing scams and pig butchering scams satisfy the criteria of a theft loss in a transaction made for profit. The two last scenarios described in the memo, romance scams and kidnapping schemes, fall under the category of personal injury 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. The memo states that taxpayers who have been victims of romance or kidnapping schemes cannot claim theft losses on their tax returns for years before 2026.
Your Guide to Forward
Online scams are becoming more sophisticated and numerous. This article will help taxpayers to report thefts resulting from these five scams. Contact Parr & Ibarra CPA for more information or any other tax issues.
