Issues

Theft Loss From a Scam Denied? The Section 165 Tax Court Guide

Lost money to a scam or Ponzi scheme and the IRS denied your theft loss? Which scams still qualify, the year that counts, and the IRA tax trap.

Liam Williams

Liam Williams

— 40 min read
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You trusted a caller claiming to be your bank's fraud department, an investment site that showed your money growing, or someone you met online. The money is gone, and now a notice of deficiency (the "90-day letter" proposing extra tax) disallows your theft loss, taxes the retirement money you withdrew for the scammer, or both.

The short answer: a theft of money you held or sent for profit can still be deducted, but since 2018 a personal theft almost never can, and retirement money you sent to a scammer is generally taxable income even when the theft is deductible.

If you have a notice of deficiency, the petition deadline is 90 days from the date on the notice (150 days if it was addressed to you outside the United States). It cannot be extended, and you do not have to pay the tax first.

Theft-loss cases turn on five questions:

  1. Profit. Was the money held or sent for profit? Since 2018, a personal theft is deductible only in rare disaster cases.
  2. Theft. Was it a crime under the law of the place where it happened?
  3. Ownership. Was the stolen money yours, not a company's or a fund's?
  4. Year. Is it the year you discovered the theft, with no reasonable prospect of getting the money back?
  5. Amount. What was your basis: the money you actually put in, not the balance the scammer showed you?

Where To Start, Depending on Your Loss

The Short Answer: Investment Thefts Survive, Personal Thefts Do Not

IRC § 165(a) allows a deduction for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." But § 165(c) limits individuals to three kinds of loss:

  • Business losses (§ 165(c)(1)), such as embezzlement from a business you run. Managing your own investments is not a business (Baum v. Commissioner, T.C. Memo. 2021-46).
  • Losses in a transaction entered into for profit (§ 165(c)(2)): investment scams, Ponzi schemes and most fraud on investment accounts.
  • Personal losses (§ 165(c)(3)), from "fire, storm, shipwreck, or other casualty, or from theft": romance scams and fake-kidnapping ransoms, for example.

The wall for personal thefts. Under § 165(h)(5), a personal casualty or theft loss for a tax year beginning after 2017 is deductible only to the extent it is attributable to a federally declared disaster or, from 2026, a State declared disaster (or offsets personal casualty gains). The One Big Beautiful Bill Act (Pub. L. 119-21, § 70109) made the bar permanent. Scams are rarely tied to a declared disaster (the disaster test), so in practice a personal theft is no longer deductible.

Why investment thefts get through. The wall applies only to a "personal casualty loss", which § 165(h)(3)(B) says "means any loss described in subsection (c)(3)." A business or for-profit theft escapes both the wall and the floors that shrink personal losses. Still, as the Taxpayer Advocate Service warns: "Just because you’re a victim of a scam doesn’t mean you can deduct the loss on your tax return."

Which Side of the Line Is Your Scam On?

No Tax Court opinion we found applies these rules to a pig-butchering, crypto, romance, impersonation or AI-voice scam. The fullest statement of the IRS's view is Chief Counsel Advice (CCA) 202511015, a January 2025 memo from the IRS's lawyers analyzing five victims who discovered their losses in 2024.

The memo's test is your motive when the money moved. The Code never defines a transaction entered into for profit, but, the memo explains, "courts have analyzed this phrase and held that a primary profit motive is required under § 165(c)(2)." Under the memo:

  • Money already invested when the scammer appeared was held for profit.
  • Money moved at the scammer's direction keeps that character if you moved it to protect or reinvest it, even with a stop in a temporary account, crypto or gold.
  • Money taken without your authorization takes its character from why you invested it.
  • Money sent for another reason, such as helping someone or paying a ransom, is a personal loss.

The Memo's Five Scenarios

Scam What happened Why the money moved The IRS's conclusion
Compromised account Someone posing as a fraud specialist at the victim's financial institution said the accounts were compromised, so the victim moved IRA and other money into new accounts the scammer opened. To safeguard and reinvest it Deductible. The taxed IRA distribution and the gain or loss recognized on the non-IRA assets give basis in all the stolen funds.
Pig butchering An unsolicited email pitched a crypto investment. Two early withdrawals worked, so the victim invested much more; then a withdrawal failed and support went silent. Investment Deductible. No Ponzi safe harbor (explained below), because the scammer was never identified or charged.
Phishing (and hacked accounts) An official-looking email led the victim to log in through a link, and by the next day the accounts had been emptied. Nothing was authorized, so the original investment controls Deductible, with basis to the extent the IRA distribution is taxed and gain or loss is recognized on the non-IRA assets.
Romance A virtual relationship began with an unsolicited text. The scammer said a close relative needed medical care. To help someone Not deductible. The IRA distribution is still taxed.
Fake kidnapping Texts and a call, in what sounded like the grandson's voice (cloned with AI), demanded ransom. Ransom Not deductible. The IRA distribution is still taxed.

Deception does not supply a profit motive. Of the romance victim, the memo says: "Notwithstanding the fraudulent inducement, Taxpayer 4 did not have a profit motive when authorizing the distributions and transfers." If a romance turns into an investment pitch, though, "the analysis would be the same as for Taxpayer 2 and the pig butchering investment scam." A fake arrest of a relative is treated like the fake kidnapping.

Where the money came from. All five of the memo's victims "invested funds in IRA and non-IRA brokerage type accounts that generally invest in securities". Under the memo's reasoning, money you sent to invest takes its character from why you sent it, whether it came from savings, a loan or an investment account. Money that a fake bank caller or a hacker drained from an ordinary checking or savings account is a harder case: the memo's safeguard and hacked-account conclusions rest on the money having been invested, and we found no ruling or case on bank deposits. Scams outside the five, such as fake jobs, prizes, tech support or government debts, are untested too. The question is still why you sent the money.

How Much Weight the Memo Carries

Under IRC § 6110(k)(3), "a written determination may not be used or cited as precedent." The memo binds neither the Tax Court nor the IRS in your case. But the 2025 Instructions for Form 4684 send scam victims straight to it: "If you were the victim of a financial scam, review advice memorandum number 202511015 for additional guidance."

That makes it useful with an examiner, the IRS Independent Office of Appeals and IRS counsel. In court, the statute, the regulations and the case law decide. (The memo says the personal-loss bar applies "for tax years 2018 through 2025", the law when it was written. The bar is now permanent.)

Was It a Theft? What You Have To Prove

Profit decides whether a theft can be deducted. You still have to prove the theft, and here the Tax Court's cases apply directly.

The Law of the Place Where It Happened

In Raifman v. Commissioner, T.C. Memo. 2018-101, the Court said: "In order to ascertain whether theft has occurred, this Court applies the law of the State where the loss was sustained."

Even where the money went to overseas accounts, the IRS memo treated the scams as crimes "under the law of the state where the victims reside." Look up your state's theft or fraud statute: the Court tests the facts against the elements of a specific statute, as it did with Indiana's theft statute in Weston (below). The place can also be abroad: Potts (below) applied Turks and Caicos law.

Theft is read broadly. In Littlejohn v. Commissioner, T.C. Memo. 2020-42, the Court said the term is "intended to cover any criminal appropriation of another's property, including theft by larceny, embezzlement, obtaining money by false pretenses, and any other form of guile." Being fooled does not count against you. In Leslie v. Commissioner, T.C. Memo. 2016-171, the Court noted that "California courts have held that even reliance by a foolish victim of an absurd fraud is nonetheless reliance."

No Conviction Needed, but You Must Prove the Crime

Nobody has to be charged, and you need not know who the thief was. Deutsch v. Commissioner, T.C. Memo. 2026-66: "A criminal conviction, or even the prosecution of one, is not necessary in order for a taxpayer to demonstrate a theft loss." Investigators never identified who owned the accounts that received Mr. Deutsch's money, yet "Mr. Deutsch still suffered a theft at the hands of whoever orchestrated the scheme."

The standard is a preponderance of the evidence (more likely than not), and intent is usually proved from the circumstances. In Halata v. Commissioner, T.C. Memo. 2012-351, the red flags carried the day: "A $2.5 million return on $181,104 is too good to be true; a purported return that high is an indicator of a fraudulent scheme."

Report it. No law requires a police report, but Deutsch warns that a taxpayer's failure to claim or charge a crime of theft "may raise doubts as to whether an “actual fraud” exists." The victims in the IRS memo reported the scams to their financial institutions and to law enforcement. For internet fraud, the FBI runs the Internet Crime Complaint Center (IC3). If you did not report the scam at the time, report it now and keep copies.

Prove who deceived you, with documents. Deutsch found a theft of the $925,000 transferred toward a promised $70 million ranch financing deal, but not of the $295,600 given for living expenses to a middleman who had likely been defrauded himself. Testimony alone rarely works: the taxpayers in Potts v. Commissioner, T.C. Memo. 2025-108 lost in part because they "did not introduce any admissible evidence (e.g., wire transfers, bank statements, correspondence, etc.) corroborating a purported misappropriation."

What Is Not Theft

The Tax Court draws a firm line between a crime and a bad outcome:

  • A bad deal. Riley v. Commissioner, T.C. Memo. 2016-46: "Simply asking for money for a business isn't a false representation".
  • Breach of contract or mismanagement. In Weston v. Commissioner, T.C. Memo. 2025-16, about $2.1 million put into a home-renovation business and a demolition business in Indiana looked more like incompetence and poor investment decisions than theft.
  • Getting what you paid for. The Potts taxpayers paid $2.5 million for 25 shares: "Petitioners received exactly what was agreed upon in the 2008 Purchase Agreement: 25 shares of Carib Gaming."
  • An unpaid judgment. Littlejohn: "mere failure to pay a civil judgment does not constitute a crime of theft."
  • Vanished money or a collapsed stock. Publication 547: "The simple disappearance of money or property isn’t a theft." Nor is a drop in stock bought on the open market, even when fraud by the company's officers caused it.
  • An insider's own testimony. In Shaut v. Commissioner, T.C. Memo. 2024-103, the petitioner had been president of Downing, the company he invested in, and later its fundraiser: "His self-serving testimony alleging theft is insufficient in this case to meet his burden of proof."

Why the label matters. A for-profit loss that is neither a theft nor a capital loss is generally a miscellaneous itemized deduction, which IRC § 67 disallows for 2018 and later years; theft losses are carved out by § 67(b)(3). A worthless security is a separate capital-loss claim under § 165(g), which the Potts taxpayers never made.

The Owner Rule

Pascucci v. Commissioner, T.C. Memo. 2024-43: "The theft loss deduction is available only to the person who was the owner of the stolen property at the time it was criminally appropriated." If a company or fund you invested in was robbed, the loss is generally the entity's.

In Pascucci itself, about $8.2 million was claimed on variable life insurance policies whose separate accounts were invested with Madoff through feeder funds: "However, the Policies were not stolen." In Potts, the $2.5 million went to the trust account of the seller's lawyer, so any embezzlement took the seller's funds, not the taxpayers' property.

Ownership takes documents. In Evensen v. Commissioner, T.C. Memo. 2018-141, a self-represented Ponzi investor lost even though the IRS accepted that a Ponzi loss is a theft: "Petitioner did not present any documentation showing that she was the owner of the accounts."

Which Year? Discovery and the Reasonable Prospect of Recovery

Even a proven theft, or one the IRS concedes, loses if it is claimed for the wrong year.

The Discovery Year

Under IRC § 165(e), "any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss." Discovery turns on what you knew, not on when the wrongdoers were punished.

Mr. Shaut claimed his loss for 2019, the year he said two of Downing's principals were sentenced to prison. The Court: "Thus, it is evident that Mr. Shaut knew before 2019 that Downing was a financial failure, that improper activity occurred, and that he would not recover his investment."

A Live Chance of Getting Money Back Postpones the Deduction

Under Treas. Reg. § 1.165-1(d)(3), if a claim for reimbursement with a reasonable prospect of recovery exists in the discovery year, the part of the loss it covers waits until the year in which it "can be ascertained with reasonable certainty whether or not such reimbursement will be received."

The test is mainly objective, judged at year end. In Vennes v. Commissioner, T.C. Memo. 2021-93, the Court said it is "based primarily on objective factors; the taxpayer’s subjective belief may also be considered, but it is not the sole or controlling criterion." Deutsch: "the test is foresight, not hindsight."

Insurance claims, advances from the Securities Investor Protection Corporation (SIPC), claims against the wrongdoers or a receivership or bankruptcy estate, and lawsuits can all keep a prospect alive. A bank fraud claim, card chargeback or frozen exchange account may too, although no case we found turned on one. Two examples:

  • Gaunt v. Commissioner, T.C. Memo. 2018-78, a pre-2018 theft of stored possessions cited here only for its timing rule: "They had a pending claim for reimbursement from Allstate throughout 2010, and they spent the next six years pursuing that claim." No 2010 deduction.
  • In McNely v. Commissioner, T.C. Memo. 2019-39, the IRS conceded the theft from an S corporation the taxpayer co-owned, but the 2011 deduction failed: "By the end of 2011, M & M had not engaged an attorney, filed insurance claims, or made any effort to recoup any of the losses."

How a prospect ends: by a settlement, a court decision, or abandonment of the claim shown by objective evidence "such as the execution of a release" (Treas. Reg. § 1.165-1(d)(2)(i)). In Deutsch, it ended in 2010, when the middleman missed a final deadline and Mr. Deutsch's lawyers advised that other recovery methods would not be fruitful. The IRS memo's victims had no prospect to wait for: "Scammer A’s true identity was unknown, the transfers of funds were irreversible, the losses were not covered by insurance, the victims had no legal recourse against any third party, and law enforcement stated that there was little to no prospect of any recovery."

Which Year: A Quick Table

Your situation The year the loss belongs to
Money sent one year, scam discovered the next The discovery year (Leslie: wired 2008, discovered 2009, deductible 2009)
A claim with a realistic chance of paying was open at year end The covered part waits until it is reasonably certain whether you will be repaid (Gaunt, Vennes)
Part of the loss is covered by a live claim Split: the uncovered part in the discovery year, the rest when the claim ends (Treas. Reg. § 1.165-1(d)(3); Rev. Rul. 2009-9)
A claim ends paying less than you hoped The shortfall, in the year you can expect no more (Pub 547)
You knew years ago but waited for the criminal case The earlier year you knew; the later year is too late (Shaut: the Court found he knew before 2019; he claimed 2019)
Money came back after you deducted the loss No amendment: the recovery is income in the year received (Treas. Reg. § 1.165-1(d)(2)(iii)), but only to the extent the deduction cut your tax (IRC § 111)
A Ponzi scheme, using the safe harbor The year the lead figure was charged (Rev. Proc. 2009-20)

Wrong-year claims fail both ways: too early, while recovery was still realistically possible (Vennes, McNely, Raifman, Gaunt, Riley, Baum), or too late (Shaut, Giambrone). In Halata, the loss belonged to a year that was not before the Court at all, and so did the losses in Hommel v. Commissioner, T.C. Memo. 2020-4. There a self-represented petitioner "argues less about the details of a theft-loss deduction under the Code, and more about how he shouldn't have to owe so much tax when he lost so much and had so many reversals of fortune." The details decided his case anyway. His notice covered 2009, and the Court found: "The alleged thefts occurred and Mr. Hommel discovered them only in 2010. That's the year they would be deductible."

How Much: Your Basis, Not the Balance on the Screen

The deduction is limited to your basis (IRC § 165(b)). For investment frauds, an IRS ruling, Rev. Rul. 2009-9, measures the loss as generally "the amount invested in the arrangement, less amounts withdrawn, if any, reduced by reimbursements or recoveries, and reduced by claims as to which there is a reasonable prospect of recovery." In practice:

  • Add every dollar you put in, including fees or taxes the scammer demanded before you could withdraw, which the memo says increase the loss.
  • Add phantom income you actually reported, meaning fake profits the scheme credited to you that you included on a tax return and left in the scheme.
  • Subtract everything you took out, including early payouts meant to win your trust.
  • Subtract recoveries, and hold back amounts still realistically recoverable.
  • For crypto or securities you already owned, use your basis, not the market value. For income-producing property lost to theft, the loss is the property's adjusted basis (Treas. Reg. § 1.165-7(b)(1) and § 1.165-8(c)).
  • Never count the fake balance or the promised profit. In Haff v. Commissioner, T.C. Memo. 2015-138, the IRS conceded a Ponzi theft and $1,337,690 of basis, but the Court denied a deduction for "the additional $730,786 they claimed was owed them but was never paid." That amount had never been reported as income.

Rebuilding basis from records is covered in Cost Basis Disputes in Tax Court.

Retirement Money: Taxed Now, Deductible Later (If at All)

This is the most painful pattern in the IRS memo. Retirement money you sent to a scammer is generally taxable income, while the theft deduction may be smaller, later or unavailable.

Distributions You Authorized Are Taxed

IRC § 408(d)(1) taxes IRA distributions to "the payee or distributee". The Taxpayer Advocate Service: "If you withdrew or transferred money from your tax-deferred account, even if the money was stolen, you must report the distribution amount on your income tax return." The rollover promise is part of the con: "Scammers often falsely state that distributed IRA account funds will be rolled over into a new qualifying account that maintains its tax-deferred status and has no Federal income tax consequences."

The tax does give you basis in the stolen money, which counts toward a for-profit theft deduction. (The memo assumed traditional IRAs with no basis and did not address Roth accounts.)

Distributions You Did Not Authorize May Not Be Your Income

In fraudulent-withdrawal cases, the memo notes, courts have looked at "whether the taxpayer requested and authorized the distribution or received an economic benefit". Two Tax Court cases:

  • In Roberts v. Commissioner, 141 T.C. 569 (2013), a precedential opinion in a represented case, his wife at the time forged IRA withdrawal requests and the check endorsements. The withdrawals were not his income, and the 10% additional tax fell with them.
  • In Balint v. Commissioner, T.C. Memo. 2023-118, a self-represented collection case, his wife used a power of attorney meant to cover $1,200 a month to take far more from his IRA and a life insurance policy while he was incarcerated. Those amounts "are not includible in petitioner’s gross income for 2014."

These are alternatives, not a double benefit: if a distribution is not your income, you have no basis in it to deduct. Plead both in your petition, the not-your-income argument first and the theft loss in the alternative. The alternative works only if you discovered the theft in a year the notice covers; if you discovered it later, claim the loss for that year instead (see The Court Cannot Fix Another Year below).

To show you did not authorize a distribution, gather the custodian's distribution request forms and the signatures on them, records of where the money was sent, login and device records, and the custodian's fraud-claim file. If you claim reimbursement from the custodian, that claim also counts as a claim for recovery under the timing rules above.

The 10% Additional Tax Has No Theft Exception

Before age 59½, IRC § 72(t) generally adds 10% of the taxable part of a distribution. None of the exceptions mentions theft, fraud or scams, and neither do the 2025 Instructions for Form 5329. (The emergency-expense exception is capped at one distribution of up to $1,000 a year, and no source we found says a scam withdrawal qualifies.)

A theft deduction does not reduce the additional tax. The full exception list is in Retirement Distribution Disputes in Tax Court.

Other retirement accounts. Money from a 401(k), 403(b) or other employer plan follows the same pattern. One exception there is plan-only: distributions after you leave the employer in or after the year you turn 55 (§ 72(t)(2)(A)(v), which § 72(t)(3)(A) excludes for IRAs). It never applies to an IRA, which is why it does not help Diane in the example below. Roth accounts have their own ordering rules, also covered in the retirement guide. Whatever the account, make sure you get credit for any income tax withheld from the distribution, as shown on your Form 1099-R. A deficiency is figured without that credit (IRC § 6211(b)(1)), so check that the withholding shows up when the IRS works out what you actually owe.

A Worked Example: The IRA, the Crypto Platform and the Bank Claim

This hypothetical follows the IRS memo's pig-butchering pattern. Diane is 56 and retired early. In February 2025, a friendly stranger who texted her introduces her to a crypto trading platform. She sends $10,000 from savings, and in March the platform lets her withdraw $2,000 of supposed profit.

In June, told the money can be rolled into the platform without tax, she takes a $150,000 distribution from her traditional IRA (she has no basis in it) and sends all of it. By December the dashboard shows $410,000. When she asks to withdraw in January 2026, she is told to pay a $15,000 "withdrawal tax" first. She pays it from her bank account, and the platform goes silent.

In February 2026 she reports the scam to her bank, her local police and IC3. The bank says the earlier transfers cannot be recovered but opens a fraud claim on the $15,000 payment; assume that claim, still open at the end of 2026, gives her a reasonable prospect of recovery. In April 2027 the bank reimburses $9,000 and denies the rest. The scammer is never identified.

Year What happens Tax result
2025 $150,000 IRA distribution, authorized by Diane and sent to the platform $150,000 is 2025 income. She is under 59½ and no exception applies, so the 10% additional tax adds $15,000.
2026 Scam discovered; $15,000 still covered by an open bank claim Theft loss of $158,000: basis of $173,000 ($10,000 + $150,000 + $15,000, minus the $2,000 she withdrew), less the $15,000 still claimed. Form 4684, Section B, to Schedule A.
2027 Bank pays $9,000 and closes the claim A further theft loss of $6,000. The $9,000 is never deductible.

What the example shows:

  • The $410,000 balance counts for nothing. It was never income she reported, so it is not basis.
  • The 2026 deduction does not reach back to 2025. The 2025 tax and the $15,000 additional tax stand. If the loss is more than her 2026 income can absorb, the unused part becomes a net operating loss (NOL) carried forward, not back (see the NOL guide). In later years, an NOL from 2018 or later can generally offset only 80% of taxable income (IRC § 172(a)), so with modest income she may use it slowly, or never.
  • Interest and penalties come on top. Interest on the 2025 tax runs from April 15, 2026, the return's due date, until it is paid. If she left the distribution off her 2025 return, an accuracy-related penalty may be proposed as well (see the penalty sections below).
  • Had the $150,000 gone to a romance scammer to pay a relative's supposed medical bills, the 2025 tax would be identical, and under the IRS memo there would be no theft deduction at all.

Where the Deduction Goes on Your Return

Form 4684, Section B. A for-profit theft goes on Form 4684, Section B, using a separate Section B, Part I, for each theft, with your basis on line 20 and any reimbursement on line 21. An investment theft then runs through line 32 (property held one year or less) or line 38b (held longer) to Schedule A, line 16, which the 2025 Schedule A instructions describe as "Casualty and theft losses of income-producing property (including losses from financial scams)". A theft of business property goes through line 31 or 38a to Form 4797 instead (or, if you don't otherwise need Form 4797, straight to Schedule 1 (Form 1040), line 4).

For an investment theft, you must itemize (IRC § 63(e)(1)). The deduction for non-itemizers that a 2026 law added covers certain personal disaster losses only. If you took the standard deduction in the discovery year and itemizing now comes out ahead, the loss can be claimed on an amended return; see How To File an Amended Return. A theft of business property is deducted in figuring your income, whether or not you itemize.

The § 68 limit. From 2026, the rewritten IRC § 68 trims itemized deductions for taxpayers whose income reaches the 37% bracket, with no exception for theft losses.

Net operating losses. Under IRC § 172(d)(4)(C), casualty and theft losses under § 165(c)(2) and (3) are treated as attributable to a trade or business, so a large theft loss can create an NOL. An NOL from a tax year beginning after 2020 generally can only be carried forward (losses from 2018 through 2020 had a special five-year carryback), so Rev. Rul. 2009-9's statement that theft NOLs can be carried back three years no longer applies. The Form 172 instructions mention only disaster-related casualty and theft losses as business deductions, but the statute (and Rev. Rul. 2009-9) also covers a for-profit theft loss, so don't enter an investment theft loss as a nonbusiness deduction on Form 172, line 6. If the theft deduction falls, the NOL falls with it.

The Ponzi-Scheme Safe Harbor

Rev. Proc. 2009-20, as modified by Rev. Proc. 2011-58, gives Ponzi-scheme investors an optional shortcut that the IRS will not challenge if you qualify and follow it.

Who qualifies:

  1. A Ponzi-type arrangement, in which a lead figure takes investors' money, reports partly or wholly fictitious income, pays some investors with others' money, and appropriates some or all of it.
  2. A charged lead figure, charged by indictment or information (formal criminal charges) with fraud, embezzlement or a similar crime, or by a criminal complaint plus certain other events. Rev. Proc. 2011-58 added a route where the lead figure died.
  3. A qualified investor: a U.S. person with no actual knowledge of the fraud before it became public, in an arrangement that is not a tax shelter, who invested directly rather than solely through a fund or other separate entity (the fund itself may qualify).

What it gives. The discovery year is fixed as the year the charges were filed (under the death route, the later of the year a government civil complaint was filed or the year the lead figure died). The deduction is 95% of your qualified investment (cash in, plus phantom income you reported, less withdrawals), or 75% if you pursue third-party recovery, reduced by actual recoveries and by certain potential insurance and SIPC recoveries. You claim it on a timely filed return (including extensions) for the discovery year, using Form 4684, Section C.

What you give up: deducting more than the safe-harbor amount in that year, amending earlier years to remove the phantom income, and using § 1341 or the mitigation provisions (rules that can sometimes give relief for tax paid in earlier years).

It is optional, and failing it is not fatal. Pascucci: "The failure to meet the requirements of the safe harbor is not determinative of one’s ability to claim a theft loss resulting from a Ponzi scheme." But the conditions are enforced. In Vennes, the taxpayer's own company lost the safe harbor because he "either knew or deliberately avoided knowing" of the fraud before it became public. In Raifman, the taxpayers were not qualified investors because the evidence did not show any significant purpose for their investment other than avoiding federal income tax.

Modern scams rarely fit. Under the memo, four of the five victims did not invest in a Ponzi-type arrangement at all, and the pig-butchering victim failed the charging rule: "Scammer A was never identified or charged with any state or Federal crime."

What the Tax Court Cases Show

A date caution first. Every theft-loss opinion in this guide except Shaut concerns a tax year before 2018, when § 165(h)(5) did not yet exist. Their rules on theft, timing, ownership, basis and proof still govern investment and business thefts. But their personal-theft outcomes cannot be repeated for 2018 or later: Urtis v. Commissioner, T.C. Memo. 2013-66 (a home contractor) and Littlejohn (the purchase of a family home) would now be personal losses, barred unless tied to a declared disaster.

Why taxpayers lose: no proof of theft (the largest group); the wrong year, sometimes even with a conceded theft (McNely); not the owner (Potts, Pascucci, Evensen); unproved basis or amount (Evensen, Shaut); getting what was paid for (Potts); arguments raised too late (Mowry, Baum); and unmet safe-harbor conditions (Vennes, Raifman).

Self-represented results. Around 89% of Tax Court petitioners represent themselves. Self-represented taxpayers won theft deductions in two cases. In Urtis, a pre-2018 personal theft, the Court allowed $188,070 for 2007 after a contractor took the couple's money on a home expansion. In Partyka v. Commissioner, T.C. Summ. Op. 2017-79, a small case, the IRS conceded a tenant's theft of rental-property furnishings, and $9,194 of $29,979 was allowed for 2012, the year claimed.

Every other self-represented theft claim we reviewed lost the deduction: Evensen, Sheridan v. Commissioner, T.C. Memo. 2015-25 (decided on summary judgment, without a trial), Hommel and Shaut. Mr. Urtis and Mr. Shaut were both lawyers.

Procedure: How Theft Cases Reach the Court, and How They Are Lost

Four Ways In

  1. A notice of deficiency after an exam disallowed the theft loss. See You Just Got a 90-Day Letter From the IRS.
  2. An unreported IRA distribution, which usually starts with a CP2000 proposal and becomes a notice of deficiency if unresolved. See also our unreported-income guide.
  3. A denied refund claim. A refund disallowance is not a notice of deficiency. Unless the IRS issues one, the route is a refund suit in district court or the Court of Federal Claims under IRC § 7422, which generally must be filed within two years after the IRS mails its notice of disallowance (IRC § 6532(a)(1)). See Tax Court vs. District Court vs. Court of Federal Claims.
  4. Collection due process (CDP), if you never received a notice of deficiency or otherwise had no earlier chance to dispute the liability (IRC § 6330(c)(2)(B)). The IRS conceded in Gaunt that the notice was never received; in Riley and Balint the tax came from the taxpayer's own return, so no notice was ever issued. Request the hearing within 30 days of the date on the levy or lien notice. If Appeals rules against you, the Tax Court petition is due within 30 days of the date on its Notice of Determination, not 90 days; see Collection Due Process Hearings.

If you missed the petition deadline, see You Missed the 90-Day Deadline. Now What?. If an exam has already led to an assessment, audit reconsideration is a way to ask the IRS to look again outside the Tax Court.

A refund the IRS pays is not agreement. In Yaryan v. Commissioner, T.C. Memo. 2018-129, carryback refunds from a $573,398 theft loss claimed for 2011 were paid, yet the parties later agreed that the deduction, and the carrybacks and carryforwards tied to it, failed.

Put the Theft Loss, and Every Alternative, in Your Petition

Your petition lists each error you say the IRS made (your "assignments of error"), and Tax Court Rule 34(b)(1)(G) is strict about it: "Any issue not raised in the assignments of error will be deemed conceded." A loss never claimed on the return can still be raised for a year in the notice. Mr. Shaut claimed his on an amended return after the notice, and the Court decided it on the merits (against him).

Telling the examiner is not pleading (putting the issue in your court papers). In Mowry v. Commissioner, T.C. Memo. 2018-105, the taxpayer had told the revenue agent that his brother took money from their company, but "Petitioners did not raise the issue of a theft loss deduction in the petition, at trial, or in their opening brief."

So alternatives belong in the petition from the start: theft, a worthless security, a bad debt and each possible loss year in the notice. Under Rule 41(a), you can amend the petition once without permission before the IRS answers; after that, you need the Court's permission or the IRS's written consent.

On the simplified petition, Form 2, item 5 asks why you disagree and item 6 asks for the facts you rely on. List each adjustment and each penalty as its own error. For example, if the IRS disallowed an $80,000 theft loss for 2024, the wording could be as simple as this:

Item 5: (a) The IRS erred in disallowing the $80,000 theft loss deduction for 2024. (b) The IRS erred in determining the accuracy-related penalty for 2024.

Item 6: In 2023 and 2024 I sent $85,000 from my brokerage account to an online trading platform to invest it. The platform let me withdraw $5,000, then showed me profits that did not exist and refused my later withdrawal requests. In March 2024 it stopped responding. That month I reported the theft to my brokerage firm, my local police and the FBI's Internet Crime Complaint Center. By the end of 2024 I had no reasonable prospect of recovering any of the money, and nothing has been recovered.

If the notice also adds an IRA distribution you did not authorize, make that a separate error, and the 10% additional tax another. How To File Your Tax Court Petition covers the rest.

Knock-on effects need pleading too. Halata proved the theft, but "Halata never filed a pleading asserting her theory that there was a net-operating loss for 2009 that should be carried back to prior years." The Court: "Therefore she is barred from asserting it." Carrybacks are generally gone for losses after 2020, but an NOL carryforward into a year in the notice works the same way: it must be pleaded, then proved with the loss year's full records.

The Court Cannot Fix Another Year

IRC § 6214(b) lets the Court consider other years' facts, "but in so doing shall have no jurisdiction to determine whether or not the tax for any other year or calendar quarter has been overpaid or underpaid." Its refund power under IRC § 6512(b)(1) reaches only the year before it.

The fix is a timely refund claim for the right year. Under IRC § 6511(a), that generally means within 3 years of filing the return or 2 years of paying the tax, whichever is later. There is no special period for thefts; the longer period in § 6511(d)(1) covers only bad debts and worthless securities.

If the IRS says the loss belongs to a year you are not litigating, consider a protective refund claim for that year: a timely claim the IRS holds until the open question is resolved. Our amended-return guide explains what it must contain, and the IRS's procedures are in IRM 25.6.1. Even a timely claim can be capped by the refund limitation trap.

Once that year has closed, the escape routes are narrow. The IRS's position (Rev. Rul. 2009-9) is that a for-profit theft loss does not qualify for § 1341 or for the mitigation provisions (IRC §§ 1311-1314, which can reopen some closed years). The ruling's reasoning concerns reopening the years in which phantom income was reported. It does not discuss the double-disallowance rule in IRC § 1312(4), which covers a final decision that disallows a deduction that should have been allowed for another year. That rule can reopen the right year only if a refund for it was not yet barred when you first claimed the loss in writing for the year in the notice (IRC § 1311(b)(2)(B)), and the claim then has to be made within a year after the decision becomes final (IRC § 1314(b)). Get professional advice before relying on it. See also Understanding IRS Statutes of Limitations.

Burden of Proof, Small Cases and Settlement

The burden is on you. The IRS's determination "has the support of a presumption of correctness, and the petitioner has the burden of proving it to be wrong" (Welch v. Helvering, 290 U.S. 111 (1933)), and "an income tax deduction is a matter of legislative grace" (INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), quoting an earlier decision). See Burden of Proof in Tax Court.

If the amount in dispute is $50,000 or less for each year, you can elect small case procedures, whose decisions "shall not be treated as a precedent for any other case" (IRC § 7463(b)). That is why Partyka is an example, not authority. See Small Case or Regular Case.

Once the Court serves your petition on the IRS, the IRS has 60 days to file its answer, and most cases are then referred to the IRS Independent Office of Appeals for settlement talks; see What Happens After You File Your Tax Court Petition. Most (76%) of Tax Court cases close by settlement, and the IRS memo is a natural settlement exhibit. After an opinion, the parties usually work out the exact tax under the Court's rulings and submit their figures for its decision (Rule 155). See How To Settle Your Tax Court Case.

The Full Exposure Picture

A scam notice can stack the disallowed deduction, IRA distributions added from Forms 1099-R, gains from selling investments to fund the transfers, NOL carryforwards removed from later years, and penalties.

Item Typical size Main defenses
Income tax on the adjustments Your tax rate times each adjustment Prove the theft, ownership, year and amount; show that an unauthorized distribution was not your income
10% additional tax (§ 72(t)) 10% of the taxable early distribution No theft exception; it falls only if the distribution was not your income or another exception applies
Accuracy-related penalty (§ 6662) 20% of the underpayment it covers Reasonable cause; written supervisory approval; it shrinks when the tax does
Excessive refund claim penalty (§ 6676) 20% of the excessive amount Reasonable cause; no § 6676 on dollars already subject to § 6662
Late filing, late payment and estimated tax (§§ 6651, 6654) Percentages of the unpaid tax Reasonable cause (§ 6651); § 6654 has no general reasonable-cause defense, but the prior-year safe harbor and annualized-income method in § 6654(d) and the exceptions and waivers in § 6654(e) can defeat it
Interest (§ 6601) The underpayment rate, from the return's due date Falls with the tax, or on the narrow grounds in § 6404

Knock-on changes from the higher income. An added IRA distribution raises your adjusted gross income (AGI), and the notice may carry that through the rest of the return: more of your Social Security benefits can become taxable, and advance premium tax credits for marketplace health insurance may have to be repaid. An investment theft loss is an itemized deduction, taken after AGI is figured, so it does not undo those changes, even in the same year. See our guides to Social Security benefit disputes and premium tax credit disputes.

The Accuracy Penalty and Reliance on a Preparer

An understatement is substantial, as Deutsch put it, if "the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return for that taxable year or $5,000." Large theft disallowances usually cross that line. The defense is reasonable cause and good faith under IRC § 6664(c)(1).

Reliance on a preparer works only when the professional actually advised on the theft loss with full information. Deutsch won: the taxpayers "reasonably relied on the advice of their CPA (who prepared the joint return) and acted with reasonable cause and in good faith in claiming the theft loss deduction." But as Giambrone v. Commissioner, T.C. Memo. 2024-47 put it: "Simply preparing a return based on data provided by a taxpayer does not count as advice."

If you left a distribution off your return because of the rollover promise, the accuracy-related penalty can apply to the tax on it, and the defense is again reasonable cause and good faith. We found no case deciding whether a scammer's false rollover promise is reasonable cause. If the distribution was not your income at all (as in Roberts), the tax and the penalty on it fall together.

Hommel escaped the penalty only because the IRS first tried to prove written supervisory approval after trial, and the declarations it offered to tie the approval form to the examining agent were hearsay (see the § 6751(b) guide). The general defenses are in How To Fight the IRS Accuracy Penalty.

The 20% Penalty on Excessive Refund Claims

If you claim a refund for an excessive amount (for example, on an amended return claiming a theft loss), IRC § 6676 imposes a penalty of 20% of the excessive amount unless the claim was due to reasonable cause. Under § 6676(d), it does not apply to any portion already subject to the accuracy-related penalty (or the other penalties in that part of the Code).

No precedential opinion we found settles whether the Tax Court can decide a § 6676 penalty in a deficiency case. In Stevens v. Commissioner, T.C. Memo. 2025-45, a represented case that did not involve theft, the Court said "We have jurisdiction over petitioners’ liability for the section 6676(a) penalty for 2013" and sustained the penalty. That memorandum opinion is on appeal to the Ninth Circuit.

In two 2026 cases brought by self-represented taxpayers, neither about theft, the IRS put the penalty in the notice and then conceded it: Hubbard v. Commissioner, T.C. Memo. 2026-62 and Kanda v. Commissioner, T.C. Summ. Op. 2026-3. If your notice lists § 6676, raise it in the petition like any other issue.

Late-Filing, Late-Payment and Estimated-Tax Penalties

Being scammed does not, on its own, excuse filing or paying late. In Leslie, the taxpayer had been diagnosed with serious mental disorders, yet the late-filing penalties stood: "we did not see enough evidence of her inability to manage her other business affairs during this time." She was still managing eight rental properties. Contrast Torres v. Commissioner, T.C. Memo. 2021-66, where illness was reasonable cause.

In Weston, the estimated-tax waiver for "casualty, disaster, or other unusual circumstances" failed for lack of evidence. See the § 6651 guide and Estimated Tax Penalty Disputes in Tax Court.

Interest

Interest runs from the original due date of the deficiency year's return (IRC § 6601). A Tax Court case typically takes 6-18 months, and interest keeps running the whole time. A deposit under IRC § 6603, identified in writing as a deposit rather than a payment, stops interest on the amount deposited while you litigate. Any part of a deposit not yet used to pay tax is returned if you ask in writing (§ 6603(c)), but a deposit made during the audit becomes a payment when your time to petition runs out, unless before then you have petitioned and asked in writing that it stay a deposit (Rev. Proc. 2005-18, section 4.02). See How Interest Works on Your IRS Tax Debt and IRS Interest Abatement (Section 6404).

If You Cannot Pay

Many scam victims now owe tax on money they no longer have. While your Tax Court case is pending, the IRS cannot assess or collect the deficiency in dispute (IRC § 6213(a); see How IRC § 6213 Protects You While Your Tax Court Case Is Pending), though interest keeps running. Whatever is finally owed can be paid over time with an installment agreement, settled for less with an offer in compromise if you qualify, or put on hold with currently not collectible status if paying would leave you unable to meet basic living expenses. See How To Resolve Your IRS Tax Debt.

How To Check the IRS's Numbers

  1. The year: the year in the notice, the year the IRS says the loss belongs to, and whether that year is still open for a refund claim.
  2. Each adjustment: the theft deduction, the 1099-R distributions and any tax withheld from them, the § 72(t) additional tax, liquidation gains, knock-on changes such as taxable Social Security, NOL changes in later years, and each penalty.
  3. Your basis: money in (including fees paid to the scammer), plus phantom income you reported and reinvested, less money out (including early payouts), recoveries and amounts still realistically recoverable.
  4. The itemizing and NOL math, including the § 68 reduction for 2026 and later.
  5. Each retirement item: whether you authorized it, whether a rollover actually happened, and whether the § 72(t) amount is 10% of the taxable part only.
  6. Each penalty: the substantial-understatement threshold, the § 6676(d) overlap, supervisory approval and, for § 6654, the prior-year safe harbor.
  7. Interest and transcripts: the interest start date, and whether your transcripts match your own records.

Documents To Gather

  • The theft: every message with the scammer, screenshots of the website and dashboard, any contracts, your reports to your bank and to law enforcement (with dates and report numbers) and any replies, and any investigator's or lawyer's findings.
  • Ownership and the money trail: account statements in your name, entity documents if the money went through a company or fund, wire confirmations, bank statements, crypto exchange records and wallet histories.
  • Retirement and investment forms: Forms 1099-R and 5498, and Forms 1099-B for investments sold to fund the transfers.
  • Basis and the year: records of every deposit and withdrawal; earlier returns showing phantom income you reported (copies can be ordered with Form 4506); evidence of when you discovered the theft; and every recovery attempt and its result, including bank claims, insurer letters, lawsuits, receivership notices, releases and any law enforcement statement that recovery is unlikely.

Transcripts. You can order your own through Get Transcript or by phone or mail. Per the IRS's transcript guide, the tax return transcript shows your original return as filed, for the current and three prior years, and the tax account transcript shows changes made after you filed. The wage and income transcript helps spot a 1099-R you never saw, but the guide warns that it "will only display information return documents that have been filed with the IRS which may not reflect all the information return documents issued to you." A tax professional with your power of attorney can obtain more detailed IRS account records than these.

See How To Get and Read Your IRS Transcripts and How To Read IRS Transcript Codes. For getting it all into the trial record, see How To Prepare Your Evidence for Tax Court and Stipulation of Facts (Rule 91).

Common Mistakes

  • Claiming a personal scam (romance, kidnapping, fake arrest) as a theft loss for 2018 or later.
  • Picking the wrong year: the year the money left, a year when a realistic recovery claim was still open, or a later year after waiting for the criminal case to end.
  • Counting the dashboard balance, or forgetting to subtract early payouts.
  • Assuming an IRA distribution you authorized is tax-free because it was stolen, or that the 10% additional tax has a theft exception.
  • Claiming both retirement routes: you have no basis in a distribution that was not your income.
  • Skipping the police and bank reports.
  • Leaving the theft loss, or the alternatives, out of the petition.
  • Letting the refund period lapse for the right year. There is no seven-year period for thefts.
  • Using the Ponzi safe harbor without a charged lead figure.
  • Relying on a preparer who never analyzed the theft loss.
  • Amending the deduction year after a recovery.

Legislation Watch: H.R. 9500 Is Not Law

If the current rules seem unfair, the National Taxpayer Advocate agrees that they need changing. In an April 2025 blog post, the Advocate wrote that taxpayers still need legislative remedies "to prevent scam victims from being taxed on money they never truly received." The 2026 Purple Book adds that proving a profit motive "may be plausible for investment scams, but it is nearly impossible for romance or scare tactic scams."

The Tax Relief for Fraud Victims Act, H.R. 9500, "Passed the House of Representatives September 15, 2026." It was received in the Senate and referred to the Committee on Finance on September 16, 2026. As of October 4, 2026, that is the latest action.

As passed by the House, the bill would, among other things, repeal the § 165(h)(5) bar, let fraud victims elect to deduct a theft loss in the year it occurred instead of the year of discovery, keep refund claims for those deductions open longer, and add a § 72(t) exception for distributions tied to deductible fraud thefts. Some provisions would reach back to losses and distributions after 2020.

None of this is law. The bill may change in the Senate or never pass. Do not file a return, an amended return or a petition based on it, and check its status again before relying on anything it says.

What To Do Now

  1. Calendar the deadline: 90 days from the date on a notice of deficiency, with no extensions, or 30 days from the date on a CDP Notice of Determination. The filing fee is $60, and it can be waived. See How To File Your Tax Court Petition.
  2. Place your scam among the memo's five scenarios, with documents showing why the money moved.
  3. Fix the year and the amount: when you discovered the theft, which recovery claims were open at that year's end, and your basis net of withdrawals and recoveries.
  4. Sort the retirement money: which distributions you authorized, and what each Form 1099-R says.
  5. Cover every issue in the petition: the theft loss, the year, the amount, each distribution, each penalty and each alternative theory.
  6. Check the other year. If the right year may not be the one in the notice, check whether a refund claim for it is still timely.
  7. Gather the documents above, and bring the IRS memo to settlement talks with Appeals or IRS counsel.
  8. Plan for what you may owe. Collection of the disputed tax waits while your case is pending, but interest does not (see If You Cannot Pay above).
  9. Get help early if the case is large, spans several years, or involves retirement money.

Get Help

Theft-loss cases are evidence-heavy. In the most recent National Taxpayer Advocate comparison, represented petitioners prevailed at trial in whole or in part about 23% of the time, versus about 12% for those who represented themselves.

If your income is at or below 250% of the poverty line and the amount in dispute is at or below $50,000, a Low Income Taxpayer Clinic may be able to represent you for free or at low cost. The Taxpayer Advocate Service's theft-loss page is a plain-language starting point, and When To Get Professional Help With Your Tax Dispute covers larger cases.

Resources

Statutes and regulations:

IRS guidance, forms and publications:

Taxpayer Advocate Service:

Reporting the scam:

Pending legislation (not law):

Tax Court:

Cases cited:

Companion articles on TaxCourtHelp:

This article is for informational purposes only and does not constitute legal or tax advice. For advice specific to your situation, consult a qualified tax professional or attorney.

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TaxCourtHelp.com is not affiliated with the United States Tax Court or any government agency. This site provides general information only and does not constitute legal or tax advice.