Change May Be Coming for Scam Victims Who Are Required to Pay Taxes on Their Stolen Money

Why the law changed in 2017, and its impact

So why was the deduction for money stolen through scams removed? “No one really knows,” says Anderle. “Usually, you get committee explanations about particular positions. There wasn’t one here. It was a rushed process. There was no official reasoning behind why victims of theft should have their taxes so dramatically increased. He adds that many victims have already lost their savings, "and now they have a tax bill that would require them to sell their house to pay it. It’s devastating."

That was the case for Lori Flowers, 57, an oncology account specialist for a pharmaceutical company in North Carolina. A few years ago, she fell in love with a handsome man online — Herman Huysman from Belgium — after he reached out to her on LinkedIn to ask for advice about moving to her area of the state. He then spent months carefully grooming her. After she grew to care about and trust him, he said, “Lori, I need your help.” She eventually ended up “loaning” him $675,000 — nearly all of her savings, including funds from her 401(k), plus loans. “This man was masterful at manipulating my emotions,” notes Flowers. “I was like a lovesick teenager.”

When she finally discovered he was a scammer, she was devastated. Then she learned that she’d have to pay $225,000 in federal taxes on the money stolen. Because of that massive tax bill, she was forced to file for Chapter 13 bankruptcy, and the IRS was first in line for her money.

“It’s a revictimization by taxes,” says Flowers, who’s channeling her anger into trying to spread the word about the implications of this tax policy. (Flowers also has found solace in the AARP Fraud Watch Network’s free online support groups for scam victims. “It’s the greatest hour of my week, every week,” she says.)

It’s been a different situation for victims of Ponzi schemes. 

The Ponzi scheme exception was enacted in 2009, following the fallout from Bernie Madoff’s notorious $50 billion investment fraud. (Ponzi schemes involve paying off old investors with money from new investors to give the illusion that the initial investments were profitable.) Anderle notes that the current rule essentially “gives investors every possible opportunity to limit their taxes, but requires victims of crime and catastrophe to pay.”

Ways to fight back

If you’ve had money stolen through fraud and you’re facing a large tax bill, your options are limited for now. Here are some steps to take.

Know the exceptions. Again, victims of Ponzi schemes are allowed to use the deduction, says Clark Flynt-Barr, AARP's government affairs director for financial security. You can also claim the deduction if you experienced a scam while conducting business. “If it’s clear from the record that this transaction where you lost money was motivated by business or financial interests, then you actually are allowed the deduction,” Anderle says. “It’s all about intent. If you were trying to get a service for your business, or you were trying to enter into a legitimate financial contract, and that was your sole, primary motivation, then that loss will be allowed.”

The business exception is not a slam dunk, however. The exceptions are “highly technical and may be difficult to decipher, even for tax professionals, let alone most taxpayers,” a 2024 Senate report notes.

File an offer in compromise (OIC). An OIC is an IRS relief option that lets you settle your tax debt for less than the full amount. Scam victims experiencing financial hardship can use this to reduce their tax liabilities; however, the process is complicated and time-consuming, with a low success rate. Legal Action of Wisconsin, for example, had a case in which an octogenarian couple had $1 million stolen in a scam. The IRS did not accept their OIC. Instead, it told them to sell their home, one of their few remaining assets. “We often end up having to appeal,” says Anderle.

Seek legal assistance. Many people are hesitant to take on the IRS on their own, with good reason. It’s like a novice David battling a bureaucratic Goliath — and the OIC program is “complex, burdensome, and harsh,” according to the Senate committee report, with “stringent qualification requirements.”

Even attorneys can find it challenging. The process typically involves submitting 50 to 100 pages of documents, Nathaniel Puffer, director of the New Mexico Legal Aid Low Income Taxpayer Clinic, told the Senate committee. If you can’t afford a lawyer, look for a low-income law clinic in your area. The IRS has instructions for the OIC process on its website.

Write to lawmakers. If you want the theft deduction restored, share your thoughts with your U.S. senator. “Members of Congress care a lot about what their constituents think,” says Flynt-Barr. “When I worked on the Hill, that was the first question we’d get if we were considering sponsoring a bill: Have we heard about this from our constituents?”

The deduction is a niche topic in tax law, so many lawmakers may not be aware of the issue, she adds. “They may not know if you don’t tell them.”