No Theft Loss Deduction for a Stolen Heart

In January of 2025, the IRS issued more bad news for victims of romance scams. Applying to tax years 2018–2025, the Tax Cuts and Jobs Act of 2017 (the “TCJA”) eliminated the casualty and theft loss deductions for individuals, other than to the extent that casualty losses resulted from a federally-declared disaster. Because of the harsh effects of this change in the law, there was hope that the IRS would issue guidance that would allow some relief to taxpayers.

On March 14, 2025, the IRS released Chief Counsel Memorandum 2025110153 (“the CCM”) clarifying that victims of romance scams who hope to claim a theft loss deduction will not be able to do so because these victims’ losses did not result from a transaction entered into for profit. Instead, scam victims whose losses would otherwise qualify as personal casualty losses may not claim the theft loss deduction under I.R.C. § 165. For many such victims, the TCJA brought about an unintended double hardship. For example, certain scam victims who are convinced to liquidate brokerage accounts may face capital gains tax incurred on funds that have since been stolen, though they are unable to claim a theft loss deduction. Not only have the victim lost their assets, but they are also left with tax debt.

Profit Motive: The Key IRS Distinction

The CCM confirmed that victims of romance and kidnapping scams, unlike victims of cryptocurrency and investment schemes, may not claim the theft loss deduction because they did not have a profit motive in the transactions that caused their losses, but acted for personal reasons. The CCM outlined three examples of losses from scams that are still allowable under I.R.C. § 165(h)(5): a compromised account scam, a “pig butchering” investment scam, and a phishing scam. In each of these scams, the loss was incurred in a transaction entered into for profit, as each hypothetical victim sustained losses from illegitimate investment opportunities or transfers from investment accounts.

The CCM described two hypothetical taxpayers who sustained personal casualty losses as a result of interactions with scammers. One scammer pretended to be romantically involved with a victim, and another called a victim to demand a ransom for a family member whom the scammer falsely claimed was kidnapped. Although the victims of these scams were deceived as to the respective purposes of the transfers they made, they voluntarily transferred funds to the scammers without a profit motive. For this reason, the CCM states that losses resulting from these scams are not eligible for the theft loss deduction, unless the taxpayer has personal casualty gains that can offset the loss in the year in which the taxpayer discovers the scam or the loss is somehow attributable to a federally declared disaster.

A Costly National Trend

The romance scam example in the CCM exemplified many of the common characteristics of the relationships that romance scammers build with their victims. The hypothetical scam began with the victim receiving an unsolicited message from the scammer, who then developed a romantic relationship with the victim. Once the relationship was established, the scammer told the victim that they needed funds to cover medical expenses for a family member, convincing the victim to transfer money to the scammer’s overseas account. By the time the victim realized the nature of the relationship and transaction, they were unable to recover the transferred funds and had incurred a personal casualty loss that would not qualify for a theft loss deduction.

This story is common today, as virtual dating platforms and online scammers have proliferated. With evolving technologies and sophisticated scam strategies, even vigilant people can be drawn in and defrauded by romance scammers, resulting in national losses of hundreds of millions of dollars per year. In 2018, when the TCJA went into effect, total losses due to romance scams amounted to $143 million, exceeding losses for all other types of consumer fraud across the United States. The following years saw continual increases in total romance scam victims and losses: in 2019, the Federal Trade Commission (“FTC”) reported that national romance scam losses had increased by 40 percent from 2018, totaling $201 million lost by over 25,000 consumers. Romance scam losses peaked in 2022 at over $1.3 billion and continue to represent a large segment of consumer fraud losses, totaling over $1.2 billion in 2024.

Vulnerable Victims and Limited Recourse

Warnings from the FTC, FBI, Secret Service, and Department of Homeland Security emphasize that romance scammers are skilled at crafting believable narratives to which even careful, educated individuals can succumb. An FBI summary of romance scam risks explained that experienced romance scam artists establish seemingly genuine, trusting relationships with victims. This was the case for one anonymous victim who described her relationship with a romance scam artist to the FBI: “I felt a real soul connection with him right away. We sang to each other. We prayed with each other. We’d talk about what happened at church on Sunday.” Similarly, a recently widowed victim of another romance scam told the Department of Homeland Security that a scam artist built a strong emotional connection with her by communicating with her multiple times per day for months and telling her that he, too, had recently lost his spouse.

The Secret Service released an article explaining that romance scam artists are “expert manipulators.” Romance scammers spend significant time anonymously researching targets online and may therefore curate their online personas to most effectively scam victims based on available personal data. Scammers can be organized and experienced in their deceit, as evidenced by an overseas criminal enterprise targeting elderly victims through online romance scams that was identified by the U.S. Attorney’s Office for the Southern District of New York. The FTC warns that “even sophisticated people wise to the ways of the world have been taken in by romance scammers.” A 2018 study published in Cyberpsychology, Behavior, and Social Networking confirmed this warning, finding that highly educated people are more vulnerable to becoming victims of romance scams than less well-educated people. The same study suggested that middle-aged women are the demographic most vulnerable to romance scams.

No Deduction, But Perhaps IRS Relief?

For victims of romance and other online scams, recovering money can be challenging. Having identified a victim, a romance scammer will, according to the FTC, attempt to acquire funds quickly and in such a way that the victim will find it difficult to recover funds. One technique scammers use is to ask for wire transfers and gift cards.¹⁸ Once money has been transferred, it is difficult to recover.

Romance scam victims may have liquidated assets and incurred tax liabilities for which they no longer have the resources to pay. Per the newly released CCM, such victims are not entitled to relief via the theft loss deduction if the scam was discovered after 2018. Therefore, advising clients who are victims of romance scams, whose theft losses are disallowed under I.R.C. § 165(h)(5), and who have tax liability as a result of the scam transaction, can be challenging.

Working on behalf of one such scam victim who was defrauded of much of her retirement savings by a romance scammer, we encountered challenges associated with the TCJA-driven changes to I.R.C. § 165. The victim had been contacted by a scammer pretending to have a romantic relationship with her on a dating site. For several months, the scammer developed a relationship with the victim and eventually asked her to loan money to him, claiming that he was in physical danger overseas. The victim complied, though she acquired funds by selling securities in her brokerage account, which generated capital gains. Once she discovered that she had been scammed, the victim contacted law enforcement but was ultimately unable to recover any of the stolen funds. Having lost the bulk of her savings, which were intended to last her the rest of her life, the victim could not afford the tax liability that arose from selling securities in her brokerage account without significant economic hardship. However, her loss does not qualify for the theft loss deduction under I.R.C. § 165(h)(5).

Without the option of the theft loss deduction, the scam victim tried to obtain relief by offsetting some of her personal casualty loss with her personal casualty gains. Although a romance scam victim may offset their casualty losses to the extent of their gain, that loss deduction is only available for the tax year in which the victim discovered the loss.²⁰ The victim did not discover the scam right away, and most of her losses and related capital gains occurred the year before her scammer disappeared and she learned that she had been victimized.

For taxpayers in this situation, there may be no way to reduce the tax liability. Instead, the victim is left with the only option of seeking a collection alternative such as an Offer in Compromise (“OIC”). Unfortunately, because many of the romance scam victims may have assets that could be liquidated to pay the IRS, such as a home or other investments, they will not be eligible for an OIC based on doubt as to collectability.

Instead, victims in this situation may be able to obtain an OIC based on effective tax administration. Treas. Reg. § 301.7122-1(b)(3) states that the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. The Internal Revenue Manual (“IRM”) specifically includes a criminal or fraudulent act of a third party that is directly responsible for the tax liability as a ground for relief.²¹ The IRM states that there should be a “very close nexus between the actions at issue and the failure to comply.”²² Romance scam victims may be able to establish that “very close nexus” if the perpetrator scammed the victim into liquidating securities to send funds, and it was that liquidation that generated the tax liability at issue.